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9 Things to Know About Mutual Funds

Written by: Kristy Welsh

Last Updated: August 18, 2017

Though they’re the most popular investment vehicle among small investors, mutual funds should not be entered into blindly or lightly. Get the basics down first.

1) What are mutual funds?

Mutual funds allow multiple small investors — or shareholders — to pool their money for investing in stocks, bonds, and other securities.

2) Why choose a mutual fund over other investment options?

You don’t need a lot of money to invest in mutual funds. Minimum requirements vary, but typically range between a few hundred to a few thousand dollars. Mutual funds also offer a simple way to diversify your investment portfolio, and you can buy and sell your shares with relative ease.

3) Why should I think about a mutual fund?

Unlike investments in individual securities, a mutual fund gives you no control over your portfolio. You also have to pay capital gains taxes on distributions, even if the fund’s share price has fallen. Plus, fund fees can eat away at returns.

4) What do I need to consider when looking for a mutual fund?

Fund Category.  Your choice will depend on your goals. Options are numerous, but some of the most common mutual fund options include:

  • Bond funds
  • General equity (stock) funds
  • Balanced funds (stocks and bonds)
  • Global/international funds
  • Sector funds, representing investments in one sector of the economy
  • Index funds, replicating the components of a particular market index

Risk.  Is your tolerance high or do you need to be more conservative?

Turnover.  What percentage of the fund’s holding has changed over the past year. The lower the turnover, the better.

Fees.  You’ll have to pay standard fund management fees (be sure to look at the fund’s “expense ratio”), but “load fees” can be avoided.

Taxes.  Expect to pay them on capital gains distributions. One way to minimize them is to find out when distributions are made and time your investment after the fact so that you aren’t hit with tax bill right off the bat.

Time Horizon.  Are you in it for the long haul? If so, you may want to invest in a more volatile, and potentially more lucrative, long-term capital appreciation fund.

Past Performance.  Look at whether it has been consistent with market returns and whether there have been significant fluctuations in performance over the course of a year. Also, consider that you won’t get as comprehensive a picture of a newer fund as you will one that’s been around a while. And be sure to ask about any operational changes of late, such as a new fund manager or strategy.

Prospectus and Shareholder Reports.  Read them. Period.

5) How is an index fund different from other mutual funds?

Index funds replicate the components of a particular market index, such as Standard and Poor’s 500 index. Other mutual funds are run by a fund manager whose job it is to implement the fund’s strategy and make trading decisions accordingly.

6) What is a prospectus?

A prospectus is a document that outlines the goals, strategies, past performance, managers, and other details of the fund. This is an essential tool for comparing the pros and cons of various mutual funds. Do not make a decision without it.

7) Is there a minimum required investment in a mutual fund?

The minimum required to invest varies, but typically ranges from $500 to $3,000.

8) What are the fees for investing in a mutual fund?

Mutual funds make money off of fees paid by investors. However, fee types and amounts vary across mutual funds, so choose wisely.

Some mutual funds include load fees, or sale charges, tied to your purchase or selling off of your shares. These may be front-end load fees (paid at the time of your investment) or back-end load fees (paid when you sell your shares). While the law allows funds to charge load fees as high as 8.5 percent, most range from 3 to 6 percent.

Fortunately, not all mutual funds have load fees. Instead, they make money off of management, administration, and other types of fees.

Ideally, you want to choose a mutual fund with no load fees.

9) How do I find and invest in a mutual fund?

You can invest in mutual funds directly through fund companies, such as The Vanguard Group and Fidelity Investments. You may also go through a discount broker.

Learn more about Money Market Accounts.