Mutual Funds: The Basics
(That Most People Still Don't Know)
by www.SixWise.com
More than 80 million Americans invest in mutual funds, to
the tune of more than $6 trillion invested. Though mutual
funds have been around since the 1920s, they've grown increasingly
popular in the last couple of decades.
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One of the key benefits of investing in a mutual fund?
Someone else manages your investments, so you don't
have to.
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The Securities and Exchange Commission (SEC) defines a mutual
fund as a "company that brings together money from many
people and invests it in stocks, bonds or other assets."
Key Benefits of Mutual Funds
Much of the allure of mutual funds comes from two key benefits:
-
Diversification. Because the assets of a mutual
fund are invested into many different securities, mutual
funds provide instant diversification for your portfolio,
even if you only have a small amount to invest. You can
also choose between the many different types of mutual
funds out there, allowing you to diversify further.
-
Professional Management. With a mutual fund,
someone else is managing your investments, analyzing financial
markets, and taking care of recordkeeping -- tasks that
many individual investors don't have the time, or desire,
to do.
Mutual funds also allow you to invest in securities that
may not otherwise be available, or affordable, for an individual
investor. And, many mutual funds have small minimum investment
requirements so even beginning investors can get involved.
Finally, mutual funds offer liquidity in that you can redeem
your shares at any time, making it easy to get your money
when you need it.
Categories of Mutual Funds
There are two types of mutual funds: closed-end and open-end.
Open-end funds (the vast majority) will create a new share
to sell to an investor, while closed-end funds have a limited
number of shares available. Because there are so many mutual
funds out there -- more than 10,000 -- it's easier to think
of them in categories, and mutual funds are classified into
a number of different categories, including:
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Money Market Funds: Generally low-risk funds that
can double the interest rate of a bank checking or savings
account, and give you the ability to liquidate your assets
immediately.
-
Bond Funds: Typically riskier than money market
funds, bond funds are generally used to produce income
or stabilize a portfolio.
-
Stock Funds: Generally riskier than bond funds,
stock funds are used to grow money. Where money market
funds and bond funds can produce returns at a percentage
or two higher than the rate of inflation, stock funds
have a much higher return potential in the long run.
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Stock funds are a popular category, and are broken down
into smaller types based on the types of companies (growth
funds, value funds and blend funds) or size of companies
(large-cap funds, mid-cap funds, or small-cap funds) invested
in.
- Specialty/Sector Funds: These allow investors to
invest in a particular industry or market segment, such
as automotive, technology, health care, utilities, etc.
Though less diversified than most mutual funds, they do
provide more diversification and protection than investing
in one company.
The Fees
There are fees involved with mutual funds that will reduce
your investment returns, so learning what the fees are is
essential.
Mutual funds can either be load funds, which charge a sales
fee, or no-load funds, which do not. Further, different types
of funds, or share classes, charge different fees. No-load
funds do not have share classes, but the shares of other have
three basic categories (or are a variation of one of these):
-
A Shares: Typically these are load funds sold
through brokers that charge a "front-end" sales
charge of 3 percent to 6 percent. This charge is deducted
from your initial investment. There is also a marketing
fee called "12b-1" that's usually charged with
A share funds (this is deducted from the fund's assets,
on average it's around 0.25 percent, and you can find
information about it in the fund's prospectus).
-
B Shares: Instead of a front-end charge, B Shares
have a "back-end" fee, or redemption fee, that
you must pay if you redeem your shares in a certain number
of years. The fee can decrease every year until, after
a certain time period (usually six years), it disappears.
There may also be a 12b-1 fee, which may be higher than
that of A shares.
-
C Shares: C shares, or "level-load"
shares, have no front- or back-end sales charges, but
they have a 12b-1 marketing fee that you pay for the entire
period you own the fund, similar to no-load funds that
charge 12b-1 fees.
Mutual funds also have management fees and operating expenses,
which are reflected in the share price, not charged directly
to the shareholder. They typically range from 0.5 percent
to 1 percent, but may be higher.
Finally, while mutual funds are generally regarded as good
investments because of their diversification, you should be
aware that there's still risk involved; loss can occur from
an overall decline in financial markets. Meanwhile, mutual
funds will limit your potential for making a huge profit that
could occur from owning a single security whose value skyrockets.
Of course, in the same vein, mutual funds also protect you
from a major loss from a plummeting value, which can occur
if you own a single security.
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Sources
Forbes.com:
Mutual Funds 101
Vanguard.com
Different
Types of Mutual Funds
CNNMoney.com