You’ve probably heard the term “mutual fund” mentioned on CNBC or thrown around by certainly one of your more financially savvy friends in some unspecified time in the future.
You realize they’ve something to do with finance, but that’s about it.
On this intro to mutual funds, we’ll break it down for you.
So What the Heck Are Mutual Funds?
Mutual funds are mainly big, professionally managed portfolios that you would be able to buy shares of.
They pool together money from their initial investors (often an investment firm) and shareholders, then use the cash to purchase every kind of various securities.
Each share represents a commensurate slice of the entire portfolio, letting you purchase a bit of a bunch of various securities as a substitute of shopping for each security individually.
Each mutual fund is overseen by a minimum of one fund manager who chooses what to purchase and sell and when to do it—type of like a financial advisor who doesn’t need to hearken to you.
Why Do People Buy Mutual Funds?
Mutual funds are great for investors who need to diversify their portfolios but can’t or don’t need to buy each security individually.
Different funds also specialise in different securities and industries, so buying shares in a number of funds can offer you exposure to very large swaths of the market.
Not only do mutual funds offer you exposure to a wide selection of markets and industries, they allow you to buy into securities that you just couldn’t afford otherwise.
For instance, Warren Buffet’s Berkshire Hathaway (BRK.A) is currently sitting at over $400,000 per share.
It’s a bit out of the value range of the overwhelming majority of individual investors.
But what if a bunch of individual investors pooled their money together and acquired the stock?
Suddenly that $400,000+ price tag looks rather a lot less daunting.
Each investor would only own a portion of the stock—for instance, pay in $4,000 for 1%, $40,000 for 10%, etc.—and can be entitled to an equivalent portion of any dividends or profits that the stock generated.
Mutual funds are rather a lot like this arrangement, just rather a lot greater and rather a lot more diversified.
How Do I Make Money on Mutual Funds?
There are a number of ways you possibly can become profitable off of mutual funds.
Funds will be bought and sold like all other security at a price that reflects the online asset value (NAV) of the securities owned by the fund.
Which means you possibly can buy right into a mutual fund, wait for its shares to turn out to be more worthwhile, and sell them for a profit.
The entire buy low/sell high thing works rather a lot prefer it does with stocks and ETFs, though there are a number of differences.
Unlike stocks, mutual funds require a minimum investment of a specified dollar amount, and you possibly can only trade them after the stock markets have closed.
The following way you possibly can become profitable off of mutual funds is available in the shape of interest and dividends.
Many mutual funds specialise in bonds, dividend stocks, and/or other securities that make regular payments.
Some funds hold onto the cash they receive, but most pay it out to their shareholders as either a check or additional shares within the fund.
Finally, fund managers sometimes sell assets which have gone up in price since they first bought them.
The profit (capital gain) from those sales can also be divvied up and distributed to the shareholders.
Neat. So What’s the Catch?
There’s no such thing as a free lunch, and there’s definitely no such thing as a free mutual fund.
The primary downside of mutual funds is the yearly fees and/or commissions that they charge on top of the initial buy-in.
Passively managed funds may only charge you 0.2% of your overall investment every year, but actively managed funds may charge anywhere from 0.5% to 1.5% and even 2.5% on the high end.
Some funds even charge yearly percentages and extra fees and commissions.
The opposite big downside is the opacity of the typical mutual fund.
You might have a tough time determining what any given mutual fund has in its portfolio, and which may be a dealbreaker for some investors.
That opacity also makes it tough to check mutual funds. You’ll need to take lots of funds at their word and put lots of trust into the managers of the funds you do buy.
It’s Mutual
Mutual funds are interesting investment vehicles with each upsides and disadvantages.
You get to purchase slices of diverse portfolios and gain exposure to far more securities than you would on your individual, but chances are you’ll not know exactly what’s in each fund’s portfolio.
There are multiple ways to become profitable with mutual funds, but you could have to pay fees that eat up your returns.
So now that you realize the fundamentals, let’s discuss find out how to find the appropriate mutual funds in your investing strategy.