Open Ended Mutual Funds
Investing with Mutual Funds
Let's take a look at a few features of mutual funds.
A mutual fund:
- Invests in a portfolio of stocks, bonds, cash, or a combination, based on the type of fund it is
- Aims to distribute income and capital gains from the investments it owns, minus expenses, back to you and the other investors
- Lets you automatically reinvest your distributions to buy more shares at the current market price
If it's an open-end fund - and most are - a mutual fund generally sells as many shares as investors want to buy. The price of mutual fund shares is set in part by its current net asset value (NAV), which is calculated once per day. This means that mutual fund trades (both purchases and sales) execute just once per day, at the NAV. The NAV is the value of the fund's assets (minus fees and expenses) divided by the number of outstanding shares.
NAV = (assets - fees & expenses) / outstanding shares
The fund will also buy back any shares you want to sell at their current NAV, no questions asked. Be aware: mutual funds use what's called forward pricing. That means that when you buy or sell shares, you don't know the exact price until NAV for that day is calculated.
Before you invest in mutual funds, check out the fees, which are subtracted before return is calculated or distributions paid. You can find details about these fees in a fund's prospectus, along with its expense ratio. It shows what you'll pay every year, expressed as a percentage of your total investment in the fund.
Some funds have higher expense ratios than others. 0% is as low as it goes. 2% is high. And some fees aren't included, like transaction costs. The more often a fund manager buys and sells investments, the higher the transaction costs can be.
Some funds also charge a penalty fee to discourage you from trading in and out of a fund quickly. You can avoid those by waiting the required time before you sell - often 90 days. Check to be sure. There may be other avoidable fees, too. The prospectus is your friend when you want to know what the fees are.
Here's the bottom line: the more you pay in fund fees, the better your investment has to perform for you to have a positive return on your investment. So consider looking for funds that meet your standards and then find the ones that will cost you the least to own.
What to look for when choosing funds
Odd as it may sound, choosing funds can be easier than choosing individual investments. Every fund states its goal - called its investment objective - and how it plans to meet it. The plan is its investment strategy and the way it puts that strategy into action is its investment style. It's all in the fund's prospectus. Of course, there's no guarantee any fund will meet its goal.
Although most mutual funds concentrate on just one asset class - stocks, bonds, or cash - there are funds that contain all three asset classes for investors who don't want to own more than one fund or create their own asset allocations. There is a lot of variety within each asset class: large-, medium-, and small-company stock funds, and funds that own stock in companies of all sizes. Some stock funds concentrate on growth or even faster growth. Some concentrate on what they call value. There are some that buy dividend-paying stocks to provide income, or a combination of growth and income. You get the idea.
The same is true of bond funds, which may zero in on particular issuers, particular terms, or a particular level of risk. Ditto on money market funds which invest in cash equivalents - mostly very short-term bonds.
All of these asset classes come with unique risks, and higher potential reward typically comes with higher potential risk. Check out the fund's prospectus for more information regarding the risk that accompanies the assets in the fund, and weigh that carefully when making your investment decision.
Mutual Funds & Risks
Mutual funds are investments, so when you buy them you are taking some risks. Your principal isn't guaranteed and neither is your return. When one part of the market is in a slump - as one part almost always is - funds that invest there will probably slump too.
And then there are funds that will have problems no matter what's happening in the market, and those may not be short term. Some funds will stumble, maybe from a change in the manager, or from other factors, and may not be able to emerge from their slump for a long time, if ever.
Keep an eye on performance, especially comparing how your funds are doing in relation to relevant benchmarks These include market and mutual fund specific indexes, as well as other factors that may affect performance in the future. The quarterly report you'll get from each fund provides these numbers.
Keep in mind that each fund has unique risks and that no matter the investment objective, your investment is not guaranteed. You may lose all or a portion of the money you invested. Again, each funds' prospectus includes this information and it is important that you read and understand it before making an investment.