More than 80 million Americans invest in MUTUAL FUNDS. To understand what a mutual fund is, it is essential to know what stocks are. Stocks simply are shares of ownership in a public company. A public company is a company that is authorized to sell shares of ownership to members of the public, most commonly through a stock exchange. The share price of a mutual fund is called the Net Asset Value (NAV).
A mutual fund is a collective group of investments combined into one firm. Typically, mutual funds include stocks or bonds, but they can include short term money market instruments. There are really three ways to make money on mutual funds:
1) You can make money either on interest from bonds or dividends from stocks.
2)You can make money on capital gain if the fund manager sells securities within the fund that have increased in price.
3)You can make money if you sell your shares for a profit in a mutual fund when the securities within the fund have increased in price but the fund manager does not sell the securities.
Typically, when you make money, you have the option of either receiving a check or reinvesting the money into more shares within the fund.
BENEFITS OF MUTUAL FUNDS
*Cost efficient (low transaction costs due to high volume of securities sold)
* Easy to Manage (You have a fund manager working on your behalf)
* Eliminate the need to buy individual stocks (Large mutual funds often have hundreds of securities)
* Liquidity (You can request your shares to be converted to cash at any time)
DISADVANTAGES OF MUTUAL FUNDS
* No Personal Control (You cannot directly influence the decisions of the fund manager)
*Same Fees (Even if the fund does poorly, you still have to pay the annual fees, or “internal expense charges”)
NOT ALL MUTUAL FUNDS ARE CREATED EQUAL
Although many will tell you that buying a mutual fund is a smart investment move, how do you choose one among the 18,000 funds on the market? You could try looking at lists of top rated mutual funds, but a better idea is to ask your financial advisor. Perhaps you want to invest in the now popular green mutual funds or socially responsible mutual funds. Because we all have different financial needs and goals, you should seek a professional’s advice as to what the best option for you is.
Mutual funds are certainly not fail-proof. The industry is not created solely to make your life easier. Remember, the fund and its management are in it for a profit. Here are questions to ask yourself (or your investment advisor:
* What are the fund’s annual fees? (Even very small differences in fees can mean big differences in your returns)
* How will this fund impact my tax bill? (If you receive interest or capital gains, you will pay taxes on it)
* How old is the fund? (Sometimes brand new funds have great short term success because of only a few stocks within it)
* How often does the portfolio buy and sell securities? (This could translate to more fees and more taxes)
Even though mutual funds are usually considered to be a great investment, they are not insured by the FDIC or any other government agency. The SEC also points out in its publication, Invest Wisely: An Introduction to Mutual Funds, that the past performance of a mutual fund is not indicative of the future performance. Before you buy a mutual fund, you can ask for a prospectus. It will tell you the fund’s long term goals.
THE OPEN-END NATURE OF A MUTUAL FUND
There are three basic types of investment companies: Open-End companies, Closed-End companies, and Unit Investment Trusts (UITs). Being open-ended means that the fund (daily) issues new shares to investors and will buy back shares from investors wishing to leave the fund.
UNDERSTANDING SHARE CLASSES
There are several different share classes of mutual funds:
A-CLASS SHARES: generally the lowest costing with the highest return over the long term
B-CLASS SHARES: have a contingent deferred sales load (CDSL) that reduces over a period of time, for example – five years. The CDSL is a fee that investors pay when they redeem their funds shares. It typically will go down to nothing if the investor holds his shares for a long enough period of time.
C-CLASS SHARES: May cost you nothing upfront, with a 1 year withholding percentage fee if you leave early. These shares have higher internal costs for life.
Mutual funds are a good investment choice. But before you pick a fund off of a list, talk to your financial advisor or investment advisor.