A Guide To Mutual Fund Investing: Getting Started

Investing in mutual funds is a great way to build a diversified portfolio without the extra cost or hassle 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. They are a good option for both beginner and experienced investors as they provide instant diversification and convenient access to various investment strategies. Here are the key steps to investing in mutual funds:

1. Determine your financial goals: Identify whether you are investing for the short-term or long-term, and what specific financial objectives you want to achieve.

2. Choose an investment strategy: Decide on the level of involvement you want in managing your mutual fund investments, and consider your risk tolerance and capacity.

3. Research mutual fund options: Understand the different types of mutual funds available, such as stock funds, fixed-income funds, balanced funds, and target-date funds. Compare funds based on factors like past performance, expense ratios, load fees, and management style (active vs. passive).

4. Open an investment account: Choose an account type that aligns with your savings goals, such as an employer-sponsored retirement account, a personal retirement account (IRA), an education savings plan, or a taxable investment account.

5. Purchase shares of mutual funds: Ensure you have sufficient funds in your investment account, considering the higher investment minimums that mutual funds may have compared to other asset classes. You can buy mutual fund shares directly from the fund company or through an online broker.

6. Set up a regular investment plan: Establish a plan to invest consistently by setting up recurring investments. This can help you benefit from dollar-cost averaging and potentially pay less per share over time.

7. Monitor your investments: Periodically review your mutual fund holdings to ensure they are performing as expected and make adjustments if needed.

8. Consider your exit strategy: Keep in mind that you will eventually want to sell your mutual fund shares to meet your financial goals or withdraw during retirement. Be aware of any backend load fees or taxes you may owe on capital gains.

Determine your financial goals

Before investing in mutual funds, it is crucial to identify your financial goals and determine how mutual funds can help you achieve them. Ask yourself the following questions:

• What are my investment goals? Am I saving for retirement, my child's education, or a down payment on a house?
• What is my risk tolerance? Am I comfortable with dramatic swings in portfolio value, or do I prefer a more conservative approach?
• What is my investment horizon? Do I anticipate any liquidity concerns in the near future?
• How much money do I have available to invest?

Once you have clear answers to these questions, you can start exploring different types of mutual funds and selecting the ones that align with your financial goals and risk tolerance. Mutual funds can be broadly categorized into three types based on their asset classes: equity, debt, and hybrid funds.

Equity mutual funds primarily invest in stocks and aim for capital appreciation. They are considered risky but offer the potential for higher returns. If you plan to invest for the long term and can handle volatility, equity funds may be suitable.

Debt mutual funds focus on generating regular income by investing in debt instruments such as bonds. They are usually less volatile than equity funds and are suitable if you seek a more conservative investment approach.

Hybrid mutual funds diversify across multiple asset classes, such as equity, fixed income, gold, or real estate. They aim for both capital appreciation and income generation. Hybrid funds are a good option if you want to balance risk and returns and are unsure about investing solely in equity or debt funds.

Additionally, consider the fees and expenses associated with mutual funds, as these will impact your overall returns. Mutual funds typically have annual fees, expense ratios, or commissions. Some funds may also charge sales fees or "loads" when you buy or sell shares. It is essential to understand these costs before investing.

Research mutual funds

Researching mutual funds is an important step in the process of investing in them. Here are some key things to keep in mind when researching mutual funds:

• Past Performance: While not a guarantee of future success, a fund's historical performance can indicate how well it is meeting its stated goals. Compare past performance to similar mutual funds or benchmark indices.
• Expense Ratios: These are annual fees that compensate the fund's managers and cover the costs of buying the fund's investments. While most expense ratios are less than 1% or 2%, they can significantly impact your investment's growth over time. The industry average is 0.57%, but there are many funds that charge much less.
• Load Fees: These are sales commissions charged by the broker who sells you the mutual fund. "Load" funds charge commissions, while "no-load" funds do not. It is generally recommended to avoid load fees if possible, as they can eat into your returns.
• Management: Actively managed mutual funds aim to beat the performance of an underlying index and usually charge higher fees. On the other hand, passively managed mutual funds or index funds aim to duplicate the performance of an underlying index and typically charge lower fees. Historically, passively managed index funds have outperformed actively managed funds over the long term.
• Risk and Returns: Consider the level of risk you are comfortable with and the potential returns offered by the fund. Generally, funds with higher potential returns come with higher risk.
• Fund Prospectus: The fund prospectus contains important information about the fund, including its investment objectives, strategies, risks, and fees. Be sure to read the prospectus carefully before investing to ensure you understand the fund's risks and whether it aligns with your financial goals.
• Fees and Minimum Investments: Mutual funds may have different fees and minimum investment requirements. Be sure to consider these factors when researching funds, as they can impact your returns and the affordability of investing in a particular fund.

Outline your asset mix

The asset mix is the breakdown of all the assets within a mutual fund portfolio, such as stocks, bonds, cash, and real estate. A diversified asset mix can reduce the risk of investing and increase sources of investment returns.

There are four main categories of mutual funds: stock, money market, bond, and target-date funds. Each of these categories can be further divided into subcategories. For example, stock funds can be divided into large-cap, mid-cap, or small-cap funds, depending on the size of the companies they invest in.

When deciding on an asset mix, investors should consider their risk tolerance and investment objectives. For example, younger investors may have a higher risk tolerance and opt for a more aggressive asset mix, while older investors may prefer a more conservative mix with a higher percentage of fixed-income securities.

Additionally, investors should research the fund's overall approach, investment philosophy, and portfolio managers. Understanding the fund's performance drivers and whether those are likely to continue in the future is crucial.

• Equity Funds: These funds invest in corporate stocks and can be further categorized by the companies they focus on. For instance, some equity funds invest in large, established companies that pay dividends, while others focus on smaller, growth-oriented companies. Equity funds can also be categorized by industry, sector, or geography.
• Bond Funds: These funds invest in various forms of debt, including government and corporate bonds. The risk profiles of bond funds can vary significantly, so investors should carefully review the fund's prospectus to understand the risks.
• Money Market Funds: These funds are considered low-risk and invest in high-quality, short-term debt instruments, typically issued by governments and companies. They offer slightly higher returns than regular savings accounts.
• Index Funds: These funds track a specific market index, such as the S&P 500, and aim to match its performance. Index funds are passively managed, keeping costs low, and have consistently outperformed actively managed funds over the long term.
• Target-Date Funds: These funds automatically adjust their asset mix over time, becoming more conservative as the target date, usually retirement, approaches. They are suitable for investors who want a more hands-off approach to managing their asset allocation.

When constructing a mutual fund portfolio, investors can choose from these different types of funds to create a diversified asset mix that aligns with their investment goals, risk tolerance, and time horizon.

Buy mutual fund shares

Once you've decided on your investment goals, researched potential funds, and outlined your asset mix, you can buy mutual fund shares. You can generally do this in two ways: directly from the fund company itself, or through an online broker.

If you don't already have a brokerage account, setting one up is a simple process. When choosing a broker, consider the costs associated, the number of mutual funds available, and the research tools on offer. Charles Schwab and Fidelity are two brokers that scored well in Bankrate's 2022 Awards.

You can also hold mutual fund shares in your 401(k) or another workplace retirement plan. These investments are typically automatic and made each time you're paid by your employer.

Mutual funds can require minimum investments of anywhere from $1,000 to $5,000, and they trade only once a day after the markets close. The price for the shares is determined by the net asset value (NAV) calculated after the market closes.

It's important to be aware of the fees and charges associated with buying and redeeming mutual fund shares, as these can have a significant impact on the performance of your investment. Some funds charge load fees, which are similar to the commission paid when buying or selling stocks. Load fees can be anywhere from 4% to 8% of the amount invested. Front-end loads are charged when you first buy shares, while back-end loads are charged if you sell your shares within a certain time frame.

Other fees to look out for include level load fees, which are annual charges deducted from the fund's assets to cover distribution and marketing costs, and expense ratios, which cover the fund's operating expenses.

Keep track of your investments

Keeping track of your investments is a crucial part of investing in mutual funds. While you don't need to monitor the fund's performance daily or even weekly, checking in on your investments at regular intervals is essential to ensure that your holdings are performing well and that your investment strategy remains aligned with your financial goals. Here are some tips to help you keep track of your mutual fund investments:

Determine the Frequency of Monitoring

The frequency with which you review your investments will depend on your investment horizon and goals. If you are investing for a long-term goal, such as retirement, checking in on your mutual funds monthly or quarterly may be sufficient. On the other hand, if you are investing for shorter-term goals, you may need to monitor your investments more frequently.

Utilize Resources from Your Broker

Your broker may provide free resources to help you keep track of your investments, such as access to financial planners or investment tools. Take advantage of these resources to help you stay informed and make any necessary adjustments to your portfolio.

Consult a Financial Planner

Consider consulting a financial planner or advisor to ensure your investments remain on track. Some employer-sponsored plans or banks may offer no-cost access to financial advisors. If you need to pay out of pocket, look for advisors who charge by the hour or offer fixed fees for portfolio reviews.

Review Fund Performance

When assessing the performance of your mutual funds, avoid judging a fund based on its returns over a short period, such as a quarter or a year. Instead, look at larger performance windows, such as one to three years or three to five years. You can also compare your fund's performance to similar funds, such as comparing a balanced fund to other balanced funds.

Rebalance Your Portfolio

Over time, the asset allocation in your portfolio may drift away from your original investment strategy. For example, if you initially invested 70% in stocks and 30% in bonds, market fluctuations may cause this allocation to change. Periodically review your portfolio to ensure it still aligns with your risk tolerance and investment goals, and make adjustments as necessary.

Stay Informed about Fees and Expenses

Fees and expenses can significantly impact your investment returns over time. Keep track of any fees associated with your mutual fund investments, such as management fees, load fees, and expense ratios. Be mindful of any changes in fees, as these can affect your net returns.

By following these steps, you can stay informed and in control of your mutual fund investments, allowing you to make adjustments as needed and ensure your investments remain aligned with your financial goals.

Frequently asked questions