Understanding Mutual Funds


Mutual funds have become one of the most popular forms of investing. If you are considering beginning to invest for the first time or are looking for a new type of investment to expand and diversify your portfolio, consider the following information about mutual funds to determine whether they are right for you.

Mutual funds are structured to help people invest without needing to become experts in the current state of all available stocks and bonds. A mutual fund takes on that responsibility by researching the market, packaging together a collection of stocks and bonds, and then finding people who want to invest in that collection. These people each own a portion of the holdings in the fund, otherwise known as shares.

The money you make from a mutual fund can be paid out as a distribution made up of the dividends earned on stocks and interest from bonds. You may also receive a distribution if the fund sells securities for a profit, which is known as a capital gain, although some funds treat capital gains differently.

 If you are considering beginning to invest for the first time or are looking for a new type of investment to expand and diversify your portfolio, consider the following information about mutual funds to determine whether they are right for you.“If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price,” the Investopedia staff writes. “You can then sell your mutual fund shares for a profit.”

When it is time for you to receive a distribution, you can typically choose to receive a check or let the fund keep your money and reinvest it into more shares, giving you a larger holding and a bigger percentage of future earnings. This flexibility is one of the main advantages of mutual funds. Not only do they offer you the ability to convert your shares into cash at any time, just like individual stocks, but also spread out your risk over many individual investments to offer better protection if one stock incurs a major loss.

There are several types of mutual funds, including bond funds, which are debt issued by companies or governments. There are also general equity funds, or stocks, which provide shareholders with partial ownership in corporations and reward them as the value of that company increases over time. If a fund consists of a mix of stocks and bonds, it is referred to as a balanced fund.

Specialty funds include those that invest only in a specific sector of the economy (sector funds) or in companies from one geographic area (regional funds). Specialty funds are considered riskier than bond, equity or balanced funds. Increased risk is also associated with global and international funds, which invest in companies outside the U.S.

“In general, international funds are much more volatile than domestic funds,” states Bill Barker, CFA, a portfolio manager at Motley Fool Asset Management. “International funds generally invest only in foreign companies, while global funds may invest in some U.S.-based companies in addition to foreign companies.”

Lastly, index funds own full participation in a broad market index, such as Standard & Poor’s 500 Composite Stock Price Index (S&P 500) or the Dow Jones Industrial Average (DJIA), rather than picking and choosing portions of the market to seek to outdo the average performance. Very often, index funds are the top recommendation that financial advisers have for new investors.

“Every time I update a new edition, typically every four years, I get the same results: A low-cost index outperforms two-thirds or more of active managers over time,” states Burton Malkiel, emeritus professor of economics at Princeton University and author of “A Random Walk Down Wall Street,” now in its 11th edition, during an interview with Kiplinger.

Many investors choose to start with the solid foundation of an index fund and then purchase a few smaller investments, such as stocks, for the potential to earn a little more reward for a little more risk.

 

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