Mutual Funds 101: Best Places To Invest For Beginners

Investing in mutual funds is a great way to get started with investing. Mutual funds are ideal for investors who don't have the time or ability to choose stocks, as they allow you to leave the selection of individual stocks, bonds and other investments to professionals.

Mutual funds are an investment that pools together a large amount of money from investors to purchase a basket of securities like stocks or bonds. By purchasing shares of a mutual fund, you are owning a stake of all the investments in that fund.

There are a few steps to follow when investing in mutual funds:

1. Decide whether you want to invest in active or passive funds. Active funds are managed by professionals with the goal of beating the market, while passive funds are more hands-off and aim to mimic the market.

2. Calculate your investing budget. Consider how much money you have to comfortably invest, as well as the initial mix of funds that is right for you.

3. Decide where to buy mutual funds. You could buy directly from the company that created the fund, or through an online brokerage, which will offer a broader selection of funds.

4. Understand mutual fund fees. Mutual funds charge an annual fee for fund management, expressed as a percentage of the cash you invest.

5. Manage your mutual fund portfolio. Consider rebalancing your portfolio once a year to keep it in line with your diversification plan.

There are many reasons why investing in mutual funds makes sense, and doing a little research can make all the difference in achieving your financial goals.

Active vs. passive funds

There are two main types of investment strategies: active and passive. The main difference is that active investing involves frequent trading and attempts to beat the stock market's average returns, whereas passive investing uses a buy-and-hold strategy to track the performance of the market. Active investing is a hands-on approach that requires a portfolio manager, while passive investing involves less buying and selling and is more prevalent among retail investors.

Active Funds

Active funds are managed by professional investors with the goal of outperforming a market index, such as the S&P 500. Active fund managers attempt to beat the market through frequent, high-risk investing techniques. They identify which stocks to own and in what quantities to achieve the best returns. Active funds come with larger fees (often around 1% of the fund's assets) to pay for professional management.

Passive Funds

Passive funds, on the other hand, are managed to track the performance of a market index. They do not require an expensive investment team because they are not trying to identify the best performers. This allows passive funds to charge very low fees or sometimes no fees at all. Passive funds may sound simple, but they have consistently beaten actively managed funds over long periods of time.

Passive investing is more popular among beginners because it is a low-cost, long-term strategy. Passive investing is also less risky and requires less frequent trading. Active investing, on the other hand, is better suited for experienced investors who have market knowledge and are comfortable with high risk.

Investment budget

When it comes to investing in mutual funds, there are a few things to consider when determining your budget.

Firstly, you'll want to decide between active and passive funds. Active funds are managed by professionals aiming to beat the market, while passive funds aim to mimic the market and are often less expensive. Passive funds are a more hands-off approach, whereas active funds come with higher fees and potentially higher returns.

Secondly, you'll want to calculate your investing budget. Most mutual funds have a minimum investment amount, ranging from $100 to a few thousand dollars. You'll want to consider how much money you have to comfortably invest and choose an amount that suits your budget.

Thirdly, you'll need to decide where to buy your mutual funds. You could purchase them through an employer-sponsored retirement account, directly from the fund company, or through a traditional financial advisor or online brokerage. Each option has its own advantages and fees, so it's important to consider your budget and goals when making a decision.

Lastly, understanding mutual fund fees is crucial. Funds charge annual fees, known as expense ratios, which can impact your returns over time. Some funds also charge commissions, known as loads, while others are "no-load" or "no-transaction-fee" funds. These fees can eat into your returns, so it's important to consider them when budgeting for your investments.

By considering these factors, you can determine an appropriate investment budget for mutual funds that aligns with your financial goals and comfort level.

Where to buy

Direct Investment

You can opt for direct investment in mutual funds, which means bypassing intermediaries or distributors. This approach involves submitting a completed application form, along with a cheque or bank draft, to the approved Investor Service Centers (ISC) of the desired mutual fund or its Registrar and Transfer Agent. Alternatively, you may choose to invest online through the mutual fund's website. This direct investment route offers a straightforward way to access mutual funds without incurring additional fees associated with intermediaries.

Mutual Fund Distributors

Another option for beginners is to seek the assistance of mutual fund distributors, who are individuals or entities registered with the AMFI (Association of Mutual Funds in India). These distributors can be banks, brokerage firms, or online distribution channel providers. They facilitate the purchase of mutual funds and can provide guidance to beginners navigating the investment landscape. However, it is essential to understand the fees and charges associated with their services.

Online Brokers

Online brokerage platforms offer a convenient and popular avenue for buying mutual funds. They provide a wide selection of funds from different fund companies, giving you greater variety. When choosing an online broker, consider factors such as affordability, fund choices, research and educational tools, and ease of use. Some well-known online brokers include Fidelity, Vanguard, and BlackRock, each offering a range of mutual fund options.

Employer-Sponsored Retirement Plans

If you have an employer-sponsored retirement plan, such as a 401(k), there is a good chance you are already investing in mutual funds. These plans often default to target-date retirement funds, which adjust their asset allocation over time, becoming more conservative as you approach retirement. This option is worth exploring if you are employed and your company offers such benefits.

Robo-Advisors

Robo-advisors are an increasingly popular choice for beginners. These services use computer algorithms to manage your investments, providing a low-fee, low-friction way to invest. They often have low or no minimum investment requirements, making them accessible to those just starting. Robo-advisors offer a hands-off approach, constructing and managing portfolios on your behalf. However, it is still important to monitor your investments periodically.

Understand fees

Understanding the fees associated with mutual funds is critical as they can have a significant impact on investment performance. Fees can be complicated and vary widely, so it's important to do your research before investing. Here are some key points about mutual fund fees:

• Load fees: These are similar to commissions paid when buying or selling stocks. Load fees compensate the broker or salesperson for their time and expertise in selecting the fund. They can be charged when buying shares (front-end load) or when selling within a certain time frame (back-end load). Load fees can range from 4% to 8% of the invested amount.
• Level load or 12b-1 fees: These are annual charges deducted from the fund's assets to cover distribution and marketing costs. They are considered part of the expense ratio and are typically a fixed percentage of the fund's average net assets.
• Expense ratio: This is the annual fee charged by the fund company for fund management and other operating costs. It is expressed as a percentage of the money invested and can vary from 0.5% to 1.25% or more. Actively managed funds tend to have higher expense ratios than passively managed funds.
• Impact on performance: Load fees and expense ratios can significantly affect investment returns. Funds with loads must outperform their benchmark index or similar funds to justify the fees. Studies show that load funds often do not perform better than no-load funds. Similarly, funds with higher expense ratios tend to have lower returns.
• Actively managed vs. passively managed funds: Actively managed funds aim to beat the market but often fail to do so consistently. They also tend to have higher fees. Passively managed funds, such as index funds, aim to replicate a market index and usually have lower fees.
• Open-end vs. closed-end funds: Most mutual funds are open-end, with no limit on the number of investors or shares. Closed-end funds have a limited number of shares offered during the initial public offering and trade on stock exchanges. Their trading price may differ from the fund's actual value.
• No-load or no-transaction-fee funds: These funds do not charge sales commissions when buying or selling shares, making them a more cost-effective option for investors. Most funds available to individual investors are no-load funds.
• Impact of fees over time: Even small fees can add up and eat into your returns over time. A 1% annual fee may not seem like much, but it can significantly reduce your investment returns over a long investment horizon.

Portfolio management

When it comes to portfolio management, there are a few key considerations to keep in mind. Firstly, it's important to have a clear understanding of your investment goals and time frame. Are you investing for retirement, or do you have a shorter-term goal in mind? This will help you determine the type of mutual fund to invest in. For example, if you're investing for retirement, you may opt for a more aggressive, stock-heavy fund, whereas if you're looking to buy a yacht in five years, a more conservative fund may be more appropriate.

Another factor to consider is your risk tolerance. How comfortable are you with taking on risk in exchange for potentially higher returns? This will help you decide between different types of mutual funds, such as aggressive stock funds or more conservative bond funds. It's important to remember that mutual funds are generally considered a safer investment than individual stocks, as they offer more diversification.

When building your portfolio, diversification is key. Instead of putting all your eggs in one basket, spread your investments across different types of mutual funds to reduce risk. Consider investing in a mix of equity and debt funds, or even target-date funds that automatically adjust your asset allocation as you get closer to your investment goal.

It's also important to keep an eye on fees, as these can eat into your returns over time. Mutual funds typically charge expense ratios, which are annual fees based on a percentage of your investment. Actively managed funds, which aim to beat the market, tend to have higher expense ratios than passively managed funds, which aim to mimic the market. Additionally, some mutual funds charge load fees, which are similar to sales commissions and can impact your returns.

Finally, don't forget to reevaluate and rebalance your portfolio periodically. As your investment goals and time horizon change, you may need to adjust your portfolio accordingly. Regularly reviewing your investments will also help you stay on top of market trends and make any necessary adjustments to minimise risk and maximise returns.

Frequently asked questions