Hiring a professional to invest your money with a specific objective
A mutual fund is one way to invest in the stock or bond market without buying individual stocks or bonds. You buy shares of the mutual fund and the investment company (such as Vanguard, Fidelity, T.Rowe Price, American Funds, etc.) pools your money with thousands of other people’s money and makes investment decisions on your behalf.
Why do people invest their money in mutual funds?
The concept of mutual fund investing became popular before the days of online trading.
Commissions for stocks used to be a significant amount compared to modern times. Also, taxes on dividend income from stocks was much higher in the past. Professional management became appealing to save money on fees and taxes, not too mention the time savings of letting someone else do all the research involved.
Mutual funds follow the rules of diversification, or not putting all of your eggs in one basket. The use of mutual funds makes diversifying more affordable because an investment of $1,000 or less can be spread across 40 or more company stocks while having to pay only one commission.
For example if you’re looking for dividend income instead of picking individual stocks you can pick a dividend income fund giving you a portfolio of dividend paying stocks with a single purchase.
Mutual funds for retirement money
When used to build a total return portfolio, I consider mutual funds to be one of the top ten best investments for retirement.
You can pick specific funds such as an emerging markets fund, to get exposure to an entire asset class, or you can choose something like a balanced fund which takes a broader approach and maintains a balanced allocation to both stocks and bonds.
There are also target date funds which adjust the allocation each year as the fund gets close to its maturity year, and there are retirement income funds designed to produce monthly or quarterly pay checks.
What should I do before investing in a mutual fund?
Before investing in a mutual fund make sure you have a thorough understanding of the mutual fund fees, and learn the difference between an index fund and an actively managed fund. This information can be found in the mutual fund’s prospectus, which is a disclosure document that every fund must update on a regular basis and deliver to all prospective or current fund investors.
Each mutual fund will have a pre-defined objective, so, you can choose a fund that is very aggressive or very conservative, or somewhere in between. Every mutual fund has a prospectus which you can look it up on the Security and Exchange’s Prospectus page.
If you read the first few pages of the prospectus, it will tell you what the limitations are for the management company and describe its investment strategy. It will also tell you more about risks, shareholder information, past performance, the fund managers, fees, and specific investments inside the mutual fund.
For example, one fund may only invest only in foreign company stocks or only in highly rated Treasury bonds; other funds can invest in a multitude of things depending on what the fund’s management committee thinks would be best (this last type of fund is sometimes called an absolute return fund).
Mutual funds are not the only way to diversify
In addition to traditional mutual funds there are investment vehicles called exchange traded funds and closed- end funds, which have many similarities to traditional mutual funds, as well as some key differences.