A Beginner's Guide To Mutual Fund Investing

Investing in mutual funds is a great way to build a diversified portfolio without the hassle and high costs of investing in individual stocks and bonds. Mutual funds are investment vehicles that allow groups of investors to pool their money to purchase large portfolios of stocks, bonds, and other securities. This diversifies your investment, reducing the risk of losing value.

There are two types of mutual funds: actively managed funds and passively managed funds. Actively managed funds aim to beat the performance of an underlying index and usually charge higher fees. Passively managed funds, or index funds, aim to duplicate the performance of an underlying index and typically charge lower fees.

1. Decide on your mutual fund investment goals: Determine whether you are investing for short-term or long-term goals. If you're investing for the long term, stock mutual funds are a great choice. If you're saving for a shorter-term goal, a bond market mutual fund or a high-yield savings account may be better options.

2. Pick the right mutual fund strategy: Choose funds with an investment strategy tailored to your goals. For long-term goals, consider allocating 70%-100% of your portfolio to stock-based mutual funds. For mid-term goals, balanced mutual funds that invest in both bonds and stocks can reduce risk. For near-term goals, consider investing 30% in stock mutual funds and the rest in bond funds.

3. Research potential mutual funds: Use tools like the Mutual Fund Observer and Maxfunds to research different mutual funds. Compare past performance, expense ratios, load fees, and management style to refine your list of choices.

4. Open an investment account: If you have an employer-sponsored retirement plan, such as a 401(k), you may already have access to mutual funds. Otherwise, you can open a brokerage account and invest in individual retirement accounts (IRAs), taxable brokerage accounts, or education savings accounts.

5. Purchase shares of mutual funds: Make sure you have enough money deposited in your investment account, keeping in mind that mutual funds may have higher investment minimums. You can buy mutual funds, ETFs, and stocks, but note that mutual funds only trade once per day after the market closes.

6. Set up a plan to keep investing regularly: Set up recurring investments on a regular basis to grow your wealth over time. This can also help you pay less per share through dollar-cost averaging.

7. Consider your exit strategy: Eventually, you'll want to sell your mutual fund shares to pay for your financial goals. Keep in mind that mutual funds with backend loads will charge a fee when you cash out, and you may owe taxes on any capital gains.

Understand the basics of mutual funds

Mutual funds are an investment vehicle that pools money from multiple investors to invest in securities such as stocks, bonds, commodities, and real estate. Each share in a mutual fund represents a proportional interest in the fund's portfolio, so owning more shares means a larger interest in the fund.

Mutual funds are ideal for investors who don't have the time or expertise to choose individual stocks. They are well-diversified, reducing the risk of any single investment causing a loss. They are also more affordable and accessible than other investment options, with a low barrier to entry.

There are several types of mutual funds, including bond funds, stock funds, balanced funds, and index funds. Bond funds invest in fixed-income securities and pay regular interest to their shareholders. Stock funds focus on the long-term appreciation of stocks and dividends. Balanced funds invest in both stocks and bonds, adjusting the allocation according to their strategy. Index funds, on the other hand, aim to replicate the performance of a specific stock market index, like the S&P 500.

Mutual funds can be actively or passively managed. Actively managed funds aim to beat the market performance and are handled by professional fund managers, while passively managed funds, or index funds, aim to duplicate the performance of an underlying index. Passively managed funds tend to have lower fees and, historically, have outperformed actively managed funds over the long term.

When investing in mutual funds, it's essential to consider your financial goals and risk tolerance. Mutual funds are generally a good choice for long-term goals, such as retirement or education savings, while shorter-term goals might be better suited for other investment options or savings accounts.

Before investing, it's crucial to understand the fees associated with mutual funds, as they can impact your returns over time. These include expense ratios, management fees, load fees, and redemption fees.

Mutual funds offer an easy way to invest in a diversified portfolio of securities, making them a popular choice for both beginner and experienced investors.

Set clear investment goals

Setting clear investment goals is an essential step in investing in mutual funds for the first time. Here are some detailed instructions to help you set clear investment goals:

• Identify your financial objectives: Are you saving for retirement, buying a home, funding your child's education, or something else entirely? Knowing your financial goals will help you determine the appropriate investment strategies and types of mutual funds to consider.
• Determine your budget and risk tolerance: Figure out how much money you can comfortably invest and how much risk you are willing to take. Different mutual funds have different levels of risk, so understanding your risk tolerance will help you choose the right funds.
• Set a time horizon: Consider how long you plan to invest for. Are your goals short-term (a few years away) or long-term (decades in the future)? This will impact the types of mutual funds you should choose. For example, if you're investing for the long term, stock mutual funds are a great choice, while a bond market mutual fund might be better for shorter-term goals.
• Choose the right mix of assets: Decide on the allocation of stocks, bonds, and other holdings in your portfolio. This will depend on your goals, time horizon, and risk tolerance. For instance, a younger investor might have a more stock-heavy allocation, while someone closer to retirement should include more bonds in their portfolio.
• Select the right type of mutual fund: There are two main types of mutual funds: active and passive. Active funds aim to beat the market by actively picking stocks, while passive funds aim to match the performance of a market index. Passive funds tend to have lower fees and often outperform active funds over the long term.
• Research and compare mutual funds: Look at the fees, past performance, and investment strategies of different mutual funds to find the ones that align with your goals and risk tolerance. Compare funds within the same category to make informed decisions.

By following these steps, you can set clear investment goals that will guide your mutual fund selections and help you build a portfolio that matches your financial objectives and risk profile.

Choose between active and passive funds

There are two main types of mutual funds: actively managed funds and passive funds. Actively managed funds are run by professional investors who aim to beat a market index, such as the S&P 500. They do this by researching and identifying which stocks to own and in what quantities. On the other hand, passive funds are managed to track the performance of a market index. They do not require expensive investment teams because they are not trying to identify the best performers.

Active funds

Active funds have some advantages. They offer more flexibility because they are not required to hold specific stocks or bonds. Active funds can also use hedging strategies, such as short sales and put options, to protect against losses. Additionally, active fund managers can get out of specific holdings or market sectors when the risks become too large. Active fund managers can also tailor tax management strategies to individual investors, such as selling investments that are losing money to offset taxes on winning investments.

However, active funds also have some disadvantages. They tend to have larger fees (often around 1% of the fund's assets) to pay for professional management. Despite their best efforts, active funds often fail to match the performance of the index they are trying to beat.

Passive funds

Passive funds also have their pros and cons. One of the biggest advantages of passive funds is their low fees. Because they are not actively managed, they do not require expensive investment teams, and they do not trigger large annual capital gains taxes. Passive funds also offer good transparency because investors always know what stocks or bonds the fund contains.

However, passive funds are limited to a specific index or set of investments, so investors are locked into those holdings regardless of market conditions. Passive funds also rarely beat the market, and they may not post significant returns unless the market itself booms. Additionally, passive investors generally rely on fund managers to make decisions, so they don't have much say in what they're invested in.

Both active and passive funds have their strengths and weaknesses, and the best strategy for most investors may be to blend the two approaches. Passive funds tend to be cheaper and deliver better overall returns, but active funds offer more flexibility and can be useful for investing in illiquid or little-known securities. Ultimately, the decision between active and passive funds depends on your investment goals, risk tolerance, and the amount of time and resources you are willing to dedicate to researching and managing your investments.

Research and compare different funds

When researching and comparing different mutual funds, there are several key factors to consider.

Firstly, it is important to understand the different types of mutual funds available. These include stock, money market, bond, and target-date funds, each with its own investment focus and strategy. Stock funds, for example, primarily invest in equity or stocks, while bond funds focus on investments that pay a set rate of return, such as government bonds or corporate bonds.

Another factor to consider is the fund's investment objectives and strategy. Some funds may aim to outperform the stock market, while others may mirror a popular index like the S&P 500. Funds may also vary in terms of their investment approach, with some focusing on growth, income, or a blend of both.

It is also essential to evaluate the fees associated with mutual funds, as these can significantly impact your overall returns. Common fees include expense ratios, sales charges or loads, redemption fees, and other account fees.

When comparing funds, it is worth considering the fund's performance over time. Look at the fund's total return over different periods, such as one, five, and ten years, to get a sense of its long-term performance.

Additionally, the fund's management is an important factor to consider. Research the fund manager's qualifications, investment strategy, and track record to assess their ability to generate returns.

Other factors to consider include the fund's risk level, minimum investment requirements, and whether it aligns with your investment goals and time horizon.

By carefully evaluating and comparing these factors, you can make an informed decision when choosing a mutual fund that best suits your investment needs and objectives.

Decide on a brokerage account

If you already have a 401(k) or another employer-sponsored retirement plan, you're probably already investing in a mutual fund or two. These plans usually default to a target-date retirement fund, but there are many, many mutual funds to choose from.

If your employer doesn't offer a retirement savings plan, you can still invest for retirement with pre-tax dollars through a traditional individual retirement account (IRA). You can also use a Roth IRA, which is funded with after-tax dollars, meaning your contributions grow tax-free and you won't owe tax when you withdraw in the future.

If you're investing for a goal outside of retirement, you can open a taxable brokerage account. These lack the tax benefits of 401(k) plans or IRAs, but you can make withdrawals at any time without paying penalties. This makes them well-suited for goals you want to achieve before the federal retirement age of 59 1/2.

If you have children and want to save for their college education, you can open a 529 college savings account and invest in mutual funds.

When choosing a brokerage account, you'll want to consider:

• Affordability: Mutual fund investors can face fees from their brokerage account (transaction fees) and the funds themselves (expense ratios and front- and back-end "sales loads").
• Fund choices: Workplace retirement plans may carry only a dozen or so mutual funds. You may want more variety. Some brokers offer hundreds, even thousands, of no-transaction-fee funds to choose from, as well as other types of funds like ETFs.
• Research and educational tools: With more choice comes the need for more research. Pick a broker that helps you learn more about a fund before investing your money.
• Ease of use: You want to understand and feel comfortable with the brokerage's website or app.

Pick a brokerage

• Fidelity: Buy Side from WSJ's pick for best overall brokerage firm.
• TD Ameritrade: Buy Side from WSJ's favourite for beginners.
• Vanguard: One of the largest retirement plan providers in the US, Vanguard is known for popularising the index fund.
• Fidelity Investments: Offers a wide slate of mutual funds, as well as tools to help you trade stocks and other investments. Buy Side from WSJ's pick for best stock online stockbroker.
• American Funds: Owned by Capital Group, American Funds is a major player focused mostly on mutual funds.

Frequently asked questions