Mutual funds are often touted as being low-risk investments with high yields, and they work by investing the money of many people into multiple different stocks or other assets in order to minimize risk. In this guide, we’ll take a look at how mutual funds work, the benefits and drawbacks of mutual funds, and whether or not mutual funds are right for you. If you’re not sure about how mutual funds work or if you just want to learn more about them, keep reading!
What are Mutual Funds?
Mutual funds are vehicles for saving and investing money. Investors pool their money together, then use that capital to purchase securities such as stocks, bonds, or other assets. Mutual funds are distinct from hedge funds in several ways: there is usually a very low to no minimum amount required to invest; they are sold by investment firms like any other security; and they typically have low management fees compared with hedge funds (fees can vary). There are several types of mutual funds—index, growth and income, sector-specific equity, bond...etc.
What is an Asset Allocation Fund?
Asset allocation funds are like cookie cutters that hold many individual stocks. These funds own a portion of each company in an industry, which allows them to reap the benefits of these different companies’ success (or lack thereof). Asset allocation funds provide investors with diversification among various investments in order to reduce risk and increase return on investment. As such, these funds are particularly well-suited for those who do not have enough capital available for direct investment in every stock or industry they want exposure to.
How do they work?
In short, when a person wants to start investing in stocks, for example, but doesn’t have enough money for an individual investment (the minimum can be as little as $100), they can pool their funds with other investors and buy shares of one or more companies. A company might raise $1 million from 100 investors with each investor receiving 10,000 shares of stock. Those 100 investors now own part of that company and are exposed to all of its risks and rewards.
Are all Mutual Funds the same?
Mutual funds can generally be severed into two categories: actively managed and passively managed. Active managers attempt to outperform an index by picking stocks or other securities with (hopefully) superior returns. They charge a management fee for taking on these risks, typically between 0.30% up to even 2% annually. Passive managers seek to match an index—such as the S&P 500—and charge around 0.1% for their trouble.
Choosing the Right Mutual Fund for You
Choosing a mutual fund is an investment decision. In order to make your decision, you must understand how a Mutual Fund works and be familiar with their common characteristics. You also have to think about what type of return you’re looking for (growth or income), as well as other things like liquidity (how easy it is for your money to go in and out). You should choose Mutual Funds that align with your risk tolerance, time horizon, and overall financial plan.
Mutual Fund Investing Mistakes That You Should Avoid
The easiest way to avoid making mistakes is not taking on risk in your portfolio. Unless you’re an expert investor, it’s probably best that you put your money into mutual funds rather than stocks. Mutual funds are safer, less volatile investment vehicles than stocks because they are more diversified. The next step is picking out funds with low expense ratios and have a good track record of performance over time.