Monthly Mutual Fund Investments: A Guide To Getting Started

Investing in mutual funds is a great way to build a diversified portfolio without the hassle of picking and choosing individual investments. They are a good option for both beginner and experienced investors as they offer instant diversification and access to a professionally-managed portfolio.

There are two types of mutual funds: active and passive. Active funds are managed by professionals who research and buy with an eye to beating the market, while passive funds simply try to mimic the market and are more hands-off. Passive funds tend to be cheaper and often outperform active funds despite their efforts to beat the market.

When investing in mutual funds, it's important to consider your financial goals and risk tolerance. Are you investing for the short term or the long term? How much risk can you handle? What percentage of your portfolio do you want to allocate to stocks, bonds, or other assets?

You also need to decide where to buy mutual funds. You may already have access to mutual funds through an employer-sponsored retirement plan, or you can open a brokerage account and buy them yourself.

Keep in mind that mutual funds come with fees that will impact your returns. Be sure to understand all the fees associated with a fund before investing.

Overall, mutual funds are a great option for those looking to invest in a diversified portfolio of securities with a relatively small minimum investment.

Understand the different types of mutual funds

Mutual funds are a great way to build a diversified portfolio without the extra cost and hassle of investing in individual stocks and bonds. They are also a good option for those who don't have the time, education, money, or willingness to manage a large portfolio of investments.

There are four broad types of mutual funds: equity (stocks), fixed-income (bonds), money market funds (short-term debt), or a combination of stocks and bonds (balanced or hybrid funds). Here is a more detailed look at these types of mutual funds:

Equity Mutual Funds

Equity mutual funds buy stocks in a collection of publicly traded companies. Most mutual funds on the market (55%) are some type of equity fund. Equity funds offer a higher potential for growth but also come with more potential volatility in value. Financial planners advise that the younger you are, the more your portfolio should include equity funds, as you have more time to weather the inevitable ups and downs in market value.

Equity mutual funds can be categorised in several ways, depending on the goals of the fund:

• Funds based on company size: Some funds focus only on "large cap" or "small cap" companies, which refers to the market capitalization, or value, of the companies.
• Industry or sector funds: These mutual funds focus on a particular industry, such as technology, oil and gas, aviation, or healthcare.
• Growth and value funds: Growth funds seek stocks that fund managers believe will have better-than-average returns, while value funds look for companies whose stock is undervalued by the market.
• International, global, and emerging market funds: International funds invest in companies doing business outside the US, while global funds invest in companies doing business both in the US and abroad. Emerging market funds target countries with small but growing markets.

Fixed-Income Mutual Funds

Bond funds are the most common type of fixed-income mutual funds. Rather than buying stocks, bond funds invest in government and corporate debt. They are considered safer than stocks but have less potential for growth. Investors nearing retirement should have more bond funds in their portfolio to protect their nest egg while earning more interest than a bank savings account.

Money Market Mutual Funds

Money market mutual funds are fixed-income mutual funds that invest in high-quality, short-term debt from governments, banks, or corporations. They are considered one of the safest investments and make up 15% of the mutual fund market.

Balanced or Hybrid Funds

Also known as asset allocation funds, these funds are a combination of equity and fixed-income funds with a fixed ratio of investments, such as 60% stocks and 40% bonds. The best-known variety of these funds are target-date funds, which automatically reallocate the ratio of investments from equities to bonds the closer you get to retirement.

Index Funds

Index funds are a type of mutual fund whose holdings match or track a particular market index, such as the S&P 500. They have gained popularity in recent years due to the rise of passive investing strategies, which typically earn better returns over time than an actively managed approach. Like equity funds, index funds can vary by company size, sector, and location.

Specialty or Alternative Funds

This catch-all category includes hedge funds, managed futures, commodities, and real estate investment trusts. There is also growing investor interest in corporate socially responsible mutual funds, which avoid investing in controversial industries and instead focus on funding companies with strong environmental and labour practices.

Compare fees and expenses

When investing in mutual funds, it's important to understand the fees associated with them as these costs will significantly affect your investment returns over time. Here are some common mutual fund fees:

Expense Ratio

This is an annual fee that covers the fund's operating expenses, including management fees, administrative costs, and marketing expenses. The expense ratio is expressed as a percentage of the fund's average net assets and is deducted from the fund's returns. The average expense ratio for an active fund is 0.6%, and for a passively managed one, it's 0.12%. As of 2022, the average expense ratio for equity mutual funds was 0.44%, for bond mutual funds it was 0.37%, and for hybrid models, it was 0.59%.

Sales Charges or Loads

Some mutual funds charge sales fees, known as "loads," when you buy or sell shares. Front-end loads are charged when you buy shares, while back-end loads (or contingent and deferred sales charges) are assessed if you sell your shares before a certain date. No-load funds, on the other hand, don't have commission or sales charges.

Redemption Fees

Some mutual funds charge a redemption fee when you sell shares within a short period (usually 30 to 180 days) after purchasing them. This fee is designed to discourage short-term trading in these funds for stability. The U.S. Securities and Exchange Commission (SEC) limits redemption fees to 2%.

Other Account Fees

Some funds or brokerage firms may charge extra fees for maintaining your account or transactions, especially if your balance falls below a certain minimum.

While many mutual funds are "no-load," you can often avoid brokerage fees and commissions by purchasing a fund directly from the mutual fund company instead of going through an intermediary. Additionally, you can frequently avoid these fees by investing in a fund directly from the mutual fund company, rather than through an intermediary.

Classes of Mutual Fund Shares

The type of mutual fund shares you buy can also impact your fees. Traditional A-shares come with a front-end load of up to 5% or more, plus management fees and ongoing fees for distributions (12b-1 fees). To address this, investment companies have introduced new share classes, such as "level load" C shares, which generally don't have a front-end load but carry a 12b-1 annual distribution fee of up to 1%. Funds that charge management and other fees when investors sell their holdings are classified as Class B shares.

Consider your investment goals

Before investing in mutual funds, it is important to consider your investment goals. This means identifying what you are investing for. For instance, are you saving for a secure retirement in several decades or for a child's college education? Alternatively, you may be investing for the short term, such as for a wedding or vacation.

If you are investing for the short term, it is generally recommended to skip stock and bond mutual funds. This is because stocks and bonds can be volatile and are therefore better suited to long-term investments. Instead, opt for a short-term vehicle like a savings account or money-market fund. An exception to this is if you are investing for current income, in which case you might want to go with an income fund, which tends to be made up of income-producing assets, like dividend stocks, bonds, and real estate.

If you are investing for the long term, mutual funds are a good option. With a longer time frame, your portfolio will be able to weather the stock market's periodic losses. Over the long term, the S&P 500 offers an average annual return of about 8%.

When investing in mutual funds, it is also important to consider your risk tolerance. If you are investing for retirement, for example, you will likely want to take on less risk than if you are investing for a goal that is further in the future.

Another thing to consider is how much money you want to invest. Mutual funds may have minimum investment requirements, so you will need to make sure you have enough money to meet these requirements.

Finally, it is important to research different mutual funds before investing. Consider factors such as fees, past performance, and the types of securities the fund invests in.

Decide on an investment strategy

Before investing in mutual funds, it is important to first identify your financial goals and risk tolerance. Ask yourself: Are you investing for the short-term or the long-term? Are you saving for retirement, your child's education, or a new home?

If you are investing for the short-term, it is generally recommended to avoid stock and bond mutual funds due to their volatility. Instead, consider opting for a high-yield savings account or a money market fund, which invests in short-term debt instruments and provides a steady income with limited investment risk.

On the other hand, if you are investing for the long-term, mutual funds can be a great option. When investing for the long-term, it is recommended to have a stock-heavy portfolio, especially if you are in your 20s. As you get closer to retirement, it is advisable to increase your bond allocation to reduce risk.

When deciding on an investment strategy, you will also need to choose between active and passive funds. Active funds aim to beat the market by employing fund managers to actively pick out stocks and bonds that will outperform. These funds typically charge higher fees due to the cost of research and management. On the other hand, passive funds aim to match market benchmarks and are more hands-off, with lower fees.

It is worth noting that passive funds often outperform active funds despite their efforts to beat the market. This is mainly due to the lower fees associated with passive funds. Therefore, when deciding on an investment strategy, it is crucial to consider the fees and potential returns of each option.

Additionally, you may want to consider the different types of mutual funds available, such as stock funds, bond funds, money market funds, and target-date funds. Each type of fund has its own risk profile and investment strategy, so be sure to do your research before investing.

Finally, remember that diversification is key to reducing risk. Mutual funds themselves are a form of diversification, as they allow you to invest in a variety of securities. However, you can further diversify your portfolio by investing in multiple mutual funds with different investment strategies and focuses.

Research and choose funds

Before investing in any mutual fund, it is crucial to identify your goals and risk tolerance. Ask yourself: What are your investment objectives? Do you prioritise long-term capital gains or current income? Will this investment be used to fund college expenses or retirement? Identifying your goals will help you narrow down the vast array of available mutual funds.

Another key consideration is your personal risk tolerance. Can you tolerate significant swings in your portfolio's value, or do you require a more conservative investment strategy? Remember that risk and return are directly proportional, so you must balance your desire for returns with your ability to tolerate risk.

When choosing a mutual fund, evaluate the fund's management style. Active funds are managed by professionals who actively research and select investments with the goal of outperforming a benchmark index. Passive funds, on the other hand, aim to replicate the performance of a benchmark index and typically have lower fees.

It is also important to understand the different types of mutual funds, such as large-cap, small-cap, value, and growth funds. Large-cap funds invest in large, well-known companies, while small-cap funds focus on smaller companies. Value funds invest in stocks that are considered undervalued, while growth funds target rapidly growing companies.

When researching mutual funds, be mindful of fees, as they can significantly impact your returns. Mutual funds may have front-end or back-end load fees, charged when you buy or sell shares, respectively. Additionally, consider the expense ratio, which is the annual fee charged as a percentage of assets under management.

To evaluate a mutual fund's performance, compare its returns over one-year, three-year, and five-year periods with a benchmark and its peers. Assess the fund's volatility and turnover, as high turnover can create taxable events. A strong mutual fund should have a consistent performance track record and experienced fund managers with a proven track record.

Lastly, remember to diversify your portfolio to mitigate risk and ensure long-term stability. Consider investing in international funds, bonds, real estate, fixed-income funds, and other asset classes to create a well-rounded portfolio.

Frequently asked questions