Investing in mutual funds can be a quick and relatively inexpensive way to build a diverse portfolio of stocks and bonds, with the benefits of professional management included.
What is a Mutual Fund?
In a mutual fund, individuals pool their money to buy investments, which usually consist of stocks, bonds and cash. Professional managers handle the actual stock and bond picking. At the end of each market day, the value of the fund's investment pool is totaled and divided by the number of fund shares outstanding to determine each share's daily value.
What Fees Do Mutual Funds Charge?
Fees can come in two main forms: expenses and loads. Expenses are fees levied directly against the fund's assets to cover management fees and transaction costs. In addition, some fund companies levy charges known as 12(b)1 fees, which help pay for their own marketing.
Loads are charges levied directly against investors when they buy or sell their shares. Fund companies generally split load fees with the brokers or advisers who sell the fund's shares.
How to Pick Mutual Funds
More than 14,000 US-based funds are on the market. They range from broad-based funds that try to mimic the overall US stock market to narrowly focused funds that invest only in a single industry, such as energy or pharmaceutical companies, or in a single type of investment, such as US Treasury bonds.
Before any investor jumps in, it's crucial to ask one key question: How confident are you in your own investment skills? For those who want to take on the task themselves, online tools at Morningstar and online tools at Lipper can help you chart your course.
Do-it-yourselfers will probably want to stick with funds that charge no loads. But those who lack the expertise, inclination or time to build and manage their own portfolios might benefit from paying the loads to gain the aid of a broker or adviser.
Advantages of Mutual Funds
- Diversification: Mutual funds can spread investors' money -- and therefore their risk of loss and chances for gain -- among many companies with one easy purchase.
- Liquidity: Mutual funds can be bought or sold on any market day at the share price posted at day's end.
- Simplicity: Investors can buy into most mutual funds with very little cash, usually a few hundred dollars or less, something that's not possible with most stocks and bonds. Some funds can be bought and sold online. Others are sold through brokers and advisers.
Disadvantages of Mutual Funds
- Costs: A fund's expenses are expressed as a percentage of its total assets, or the expense ratio. They are a direct drag on an investor's returns, so it's an important point to consider. Some of the largest and least-expensive funds carry expense ratios under 1 percent. Anything higher will have to earn outsized returns to compete.
- Risk: Professional management is no guarantee against losses. Investors should try to assess their own tolerance for taking on risk before they decide what kind of a fund mix to buy.