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How to Invest in Mutual Funds
By SmartAsset Team,
4 hours ago
Investing in mutual funds is a straightforward way to build a diversified portfolio, even if you’re new to investing. By pooling your money with other investors, mutual funds allow you to buy into a wide range of securities, such as stocks and bonds, managed by professionals. To start, decide on your investment goals and risk tolerance, then choose the type of mutual fund that aligns with them. Whether you’re seeking growth, income or a balanced approach, mutual funds offer a range of options to help you achieve your financial objectives. For help investing in your own portfolio, talk to a financial advisor .
What Is a Mutual Fund?
A mutual fund is an investment vehicle that pools money from multiple investors to purchase a diversified portfolio of securities, such as stocks, bonds or a mix of both. Managed by professional portfolio managers, mutual funds offer individual investors access to a broad range of assets , which can help spread risk. Each investor in a mutual fund owns shares, representing a portion of the fund's holdings and the income it generates.
Mutual funds are typically categorized by their investment focus-such as equity funds, bond funds or money market funds-allowing investors to choose based on their financial goals and risk tolerance . One of the key benefits of mutual funds is their ability to provide diversification, which can help reduce the risk associated with investing in individual securities.
When investing in mutual funds, it is important to note investment minimums, which is the least possible amount of money required to invest in the fund. Investment minimums for mutual funds vary, with some funds requiring as little as $500 and certain funds having no minimum requirement. Others may have higher minimums.
In addition to the initial investment , investors should be aware of fees associated with mutual funds. Common fees include the expense ratio, which covers the fund's management and operational costs, and potential sales charges, known as loads, which may be applied when buying or selling shares . These fees can impact the overall returns, so it's essential to understand the cost structure before investing in a mutual fund.
Open-end funds: As the most common type of mutual fund, they allow investors to buy or sell shares at any time directly from the fund at its current net asset value (NAV) .
Closed-end funds: By contrast, these funds issue a fixed number of shares that trade on an exchange like a stock. Their prices can fluctuate above or below the NAV based on market demand.
Another important classification is passive versus active mutual funds:
Passive funds: Passive funds, often referred to as index funds , aim to replicate the performance of a specific market index, such as the S&P 500 . They typically have lower fees due to minimal management.
Active funds: Active funds, on the other hand, are managed by portfolio managers who actively make investment decisions in an attempt to outperform the market. While active funds offer the potential for higher returns, they usually come with higher fees due to the intensive management involved. Investors should choose based on their investment strategy , risk tolerance and fee sensitivity.
How to Invest in Mutual Funds
Investing in mutual funds involves a few straightforward steps that can help you build a diversified portfolio tailored to your financial goals. Here's how to get started:
Determine your investment goals. Before investing, clearly define your financial objectives. Are you saving for retirement or a major purchase, or are you simply looking to grow your wealth? Understanding your goals will help you choose the right type of mutual fund.
Assess your risk tolerance. Consider how much risk you're willing to take when investing. Mutual funds range from conservative options, like bond funds, to more aggressive ones, like equity funds. Your risk tolerance should align with your investment goals and time horizon.
Research mutual funds. Once you know your goals and risk tolerance, research mutual funds that match your criteria. Look at factors such as the fund's historical performance, expense ratio, management team and investment strategy. Many online platforms provide tools to compare funds based on these factors.
Choose a mutual fund. After conducting your research, select a mutual fund that fits your investment profile. Consider the minimum investment required and any associated fees, such as the expense ratio and sales loads, which can impact your returns.
Open an account. To invest in mutual funds, you'll need to open an account with a brokerage firm, mutual fund company or financial institution. Many online brokers offer access to a wide range of mutual funds, often with low or no transaction fees.
Make your investment. Once your account is set up, you can purchase shares in the mutual fund you've chosen. You can invest a lump sum or set up automatic contributions to buy shares regularly, which can help you take advantage of dollar-cost averaging .
Monitor your investment. After investing, regularly review your mutual fund's performance and ensure it continues to align with your financial goals. You may need to adjust your investments over time as your goals or market conditions change.
How to Pick a Mutual Fund
When comparing and evaluating mutual funds, several key metrics can help you assess whether a fund aligns with your investment goals. These metrics may include:
Expense ratio: This metric shows the fund's annual operating expenses as a percentage of its assets. A lower expense ratio means more of your money is working for you, rather than going towards running the fund.
Historical performance: While past performance isn't a guarantee of future results, reviewing a fund's performance over various time periods can provide insight into how it has navigated different market conditions.
Risk-adjusted return: Metrics like the Sharpe Ratio help investors understand how much return a fund has generated relative to the risk it has taken. A higher Sharpe Ratio indicates better risk-adjusted performance.
Fund manager tenure: The experience and track record of the fund's manager can impact its performance. A long-tenured manager with a solid track record may suggest a more stable and well-managed fund.
Turnover ratio: This indicates how frequently the fund buys and sells securities. A higher turnover can lead to higher trading costs and tax implications, potentially affecting returns.
If you’re not sure whether it’s a good investment for you, consider talking to a financial advisor.
Bottom Line
By understanding the different types of mutual funds, how they work and the key metrics to evaluate them, you can make informed decisions that align with your investment strategy. With professional management, diversification and a variety of options available, mutual funds offer a flexible and accessible investment solution for both new and experienced investors.
Tips for Investing
A financial advisor has the expertise to help you choose the right investments in your portfolio that are likely to help you reach your long-term goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
In order to calculate how your asset choices might help your portfolio grow over time, consider using an investment calculator .
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