What is a Mutual Fund?
Mutual funds are investment companies or funds formed to pursue a particular investment strategy. Instead of investing directly in stocks, bonds, or assets like real estate, an investor can buy shares in a mutual fund which owns a basket of selected assets. There are many different types of mutual funds, each of which may have a unique objective, strategy, and portfolio composition. There are stock funds or bond funds. Other mutual funds may hold diversified sets of securities across asset classes, including even cash. If you own a certain number of shares in a mutual fund, you’re indirectly investing in a percentage of each holding of those funds.
Read more about how to invest your money.
How are mutual funds valued?
The share price of mutual funds can increase and decrease, much like other publicly traded stocks. However, instead of trading like an individual stock, the value of the share of a mutual fund is dependent on the aggregate price of all the assets the fund holds. In a mutual fund, shares are purchased at the fund’s Net Asset Value (NAV). The NAV is then determined at the end of the day by dividing the value of all of the securities in the fund by the number of shares outstanding. Outstanding shares are all the shares held by all investors - individuals, institutional, and company officers.
Benefit of owning shares in a mutual fund?
Professionally managed. Mutual funds are essentially an efficient way for investors to have their money professionally managed. When a mutual fund wants to sell a stock and buy a different stock, they do so on behalf of all investors in that mutual fund.
Diversification. By owning shares in a mutual fund, the investor owns a piece of the financial performance of all underlying assets, thereby spreading the risks across a wide range of companies, industries, or even asset classes.
Liquid. Mutual funds are generally liquid in a sense that you can buy and sell them at any time. However, unlike shares, mutual funds only get priced and traded once at the end of a business day. At the end of the day, the net asset value (NAV) of the fund is assessed and each share price is calculated.
Lower fee. In exchange for managing the basket of assets, mutual funds charge a small fee, called expense ratio. Expense ratio is a fee that you have to pay on your invested assets, expressed by a percentage of your total investment. For example, if your expense is $10 on $1,000 invested, then your expense ratio is 1%. Fees reduce the performance of the investments, therefore you should look for funds with low expense ratios.
How to select a mutual fund?
Investment objective. There are different types of mutual funds offering many different types of strategies. As you consider what to buy, you should determine your investment objectives, such as whether the money is intended for retirement, funding a college education, or diversifying a portfolio. For example, some funds invest in stocks that offer good dividends, have a geographical focus, or invest in the bonds of corporations.
Broadly, categories include investing for price appreciation, investing for income, or both. If you can think of an investment objective, there is a good chance there is a fund for that.
Costs. Costs are important and can affect your long-term returns. So it’s wise to take a look at the fee structure. While it varies greatly with the strategy, typical US stock mutual fund fees are around 1% a year. This means the fund takes 1% of your holdings each year, regardless of whether they increase or decrease in value. Some take more, while others can take significantly less. If a mutual fund performs not as well as you hope, you’re still going to part with a fee that year. So, keep fees in mind when you invest.
Understand the composition and objective of the mutual fund. There are many resources available for you to determine the best funds for you. Mutual fund companies provide listings of their funds and investment categories. You will often see funds being shown with a rating and the two most popular rating agencies are Lipper and Morningstar. They generally try to determine how well a fund does in managing losses and producing profits for its specific category when compared to its peer group. You can also visit their websites and research the large universe of funds that they cover. Cost vs. Services Received. When it comes to selecting funds, there are both lower and higher service options to choose from, as laid out below:
No-load Funds. These funds don’t charge a sales commission. However, all funds charge a management fee that can vary with the strategy and the mutual fund company. Some of the most notable no-load fund companies are Vanguard and Fidelity. Both provide fund management and a simple way for people to start investing.
Load Funds: Load funds are typically offered by investment professionals where you also pay a sales commission on your investment. In exchange for paying commissions, there is the additional benefit of having a broker, financial planner, or other professional’s time and expertise. However, these fees can cost up to 5% upfront, and severely hurt long-term performance, and should be avoided when possible.
Active vs. Passive Funds. When buying a mutual fund, you will need to decide if you want an active or passive fund.
Actively managed mutual funds are held by fund managers who research and buy assets. They do this as experts hoping to “beat the market” or outperform their benchmark of sector performance. These funds can be more expensive because of the talent and resources devoted to managing the funds. However, there is no guarantee that this approach will bring you the biggest payout over the long term.
Passive investing is hands-off. It tends to be cheaper because there is no active management and often takes the form of an index-following fund like an S&P 500 fund. This is often the simplest approach, with the only decision being which index you choose.
Either way, mutual funds are subject to risk of loss, as with any investment.
Where to buy?
You can purchase shares of a mutual fund directly from a brokerage account held at places such as Vanguard or Fidelity, Charles Schwab, TD Ameritrade, and E-Trade or from full-service brokerage firms. Each company offers different benefits and fees, so do your research to figure out the best fit for you.
How to calculate your budget?
- Find a fund that fits your budget. Pick a mutual fund that has a reasonable cost that works for you. Be sure to consider that some funds have minimum investments. These are usually lower for the same fund if it is going into a retirement account.
- Decide where to buy mutual funds. Set up an account with the fund manager or brokerage firm managing your desired fund.
- Understand and scrutinize fees. Every mutual fund charges fees and expenses. These fees are almost always transparent, but you should always carry out research and compare the fees attached to different investment funds. If something feels not right to you, reach out and ask your financial advisor for a second opinion. This shouldn’t be something to shy away from. At the end of the day, it’s your finances that are on the line. Question any fees that don’t make sense. It always helps to understand why fees are charged, so you can feel more confident in your investment choices.
- Build and manage your portfolio. Mutual funds can be one piece of a bigger portfolio and offer a great and quick way to diversify. Also, like all assets, there’s always a risk involved with investing in mutual funds. You should be prepared to lose as much as you put in.
Other investment opportunities:
Mutual funds offer a great way to start building your portfolio and to rebalance your portfolio but their potential for growth can be subject to the risks and shortcomings of the broader market. Another investment category is private investments. They can be an important diversifier, but riskier and not under the same regulatory oversight as mutual funds.
Republic offers investors access to an exciting sector of private investing: Startups. Startups offer investors early-stage opportunities to invest in exciting ideas and people. You can potentially earn much more than what you would expect to earn in the average mutual fund if the company gets successfully acquired or has an IPO. Bear in mind though that you could lose your original investment here as well, as this asset class is high-risk. As for fees, Republic doesn’t charge any to investors.
Read more about how to start investing.
On the Republic platform, you can back carefully-selected startups at low minimums, as little as $10 in some cases. There’s a great potential for your money to grow with a startup, and while investing in startups carries more risk, it can be a complement to mutual fund investments. You should realize going in that startups are long-term investments, and often take as long as 10 years to see a profit (if at all).
Source: U.S. Securities and Exchange Commission, Mutual Funds and Exchange - Traded Funds (ETFs) - A Guide for Investors, April.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.
How to invest in Mutual Funds
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