So, you want to start investing? A lot of people do, but many of them never take the plunge. Investing, after all, can feel like a big risk, and it is very complex. Many people who don’t know a lot about investing see it as closely akin to gambling.
However, arming yourself with knowledge and making the right kinds of investments when you’re first getting your feet wet can make a huge difference, and give you a lot of control over your financial future.
One of the easiest ways to invest, especially when you’re just starting out, is to put money in mutual funds. Mutual funds are:
- Easier and in many cases less risky than investing in stocks and bonds
- More adjustable in terms of risk than stocks and bonds—for example, you can often choose a low risk/conservative, moderate risk, or high risk/aggressive mutual fund
- Cheaper in most cases than the best, most stable stocks
- Often traded with no commission, or less commission than stocks and bonds or real estate
- A great way to start generating passive income
- Cheaper and more likely to save you time than other investment options like real estate.
Because of all these factors, mutual funds are a great place to start your investing journey. However, as with any type of investment, it’s important to do your research up front. Here are answers to some of the most basic, frequently asked questions about mutual funds.
What are mutual funds?
Mutual funds are professionally-managed investment funds that pool money from multiple investors to purchase tradable financial assets such as stocks and bonds.
Essentially, this means that a mutual fund is controlled by an individual or board. This individual or board determines how best to invest money. Don’t worry, the people in charge of legitimate mutual funds know a thing or two about money.
The money comes from multiple investors, often from very large numbers of investors. The investors purchase shares, much as investors do with publicly traded companies. The board uses this money to purchase stocks, bonds, and other assets, and adjusts these assets as necessary to attempt to maximize profitability.
There are two factors that make mutual funds overall much more stable than publicly traded companies, though. These are:
- The fact that all the money in the fund is professionally managed—meaning that someone with a great deal of knowledge and experience is making all the important decisions
- The use of the fund to invest in multiple tradable assets—meaning that if one stock or bond loses a lot of value, the other assets in the fund will balance this out.
Many of the simplest and most stable mutual funds are designed so as to track indexes such as the Dow Jones Industrial Average or the S&P 500. Managers of these types of funds will invest in multiple companies on these indexes, meaning that the overall value of the fund will move similarly to the index.
This is obviously not a get-rich-quick scheme, as the idea here is to match the index, not beat it. However, there is also considerably less risk involved. Even after the most dire financial events, such as the Great Recession or the stock market crash that helped bring about the Depression, the major indexes eventually recovered and continued to grow.
What are some of my options when it comes to investing in mutual funds?
In addition to the aforementioned funds that seek to match major market indexes, there are several other types of mutual funds you might consider investing in. For example, there are mutual funds that seek to invest in several companies across a particular industry or industry segment, such as a biotech mutual fund.
Also, most companies that offer mutual funds offer similar funds with varying levels of risk. A conservative or low-risk fund tracking the S&P 500, for example, is managed to be stable, meaning that investors will lose less money when this index falls, but that they will also gain a little less when the index rises. An aggressive or high-risk fund tracking the S&P 500 would gain more when the index rose, but also lose more when it fell. However, both would generally move in the same direction as the index in question.
One more important distinction is the difference between ETF mutual funds and other mutual funds. ETFs, short for Exchange Traded Funds, are mutual funds whose shares may be publicly traded in much the same way as stocks and bonds. Exchange traded funds offer a little less stability than non-ETFs, but can also result in the investor making a bit more money if she or he sells at the right time. This combination of flexibility and relative security makes ETFs one of the most popular tradable investment products.
If you’re going to start investing in mutual funds but plan to start investing in specific stocks and bonds later, I’d recommend starting with investments in traditional mutual funds and moving to ETFs as a middle point between mutual funds and stocks and bonds. Diversification is also good, so having a mix of traditional and exchange traded funds in your investment portfolio could result in a greater boost and/or decreased risk to your finances.
What are some of the specific advantages and disadvantages of mutual funds?
The biggest advantages of mutual funds are their relative stability and simplicity when compared to other investments, such as stocks, bonds, and real estate.
The disadvantages go hand-in-hand with those advantages, though. Because mutual funds are generally so stable, and you’re less likely to lose large sums of money, you’re also much less likely to gain large sums. The saying “more risk, more reward” definitely holds true here.
What will I learn about investing from mutual funds?
Mutual funds can give you a sweeping education in investing, but at less risk to you than stocks and bonds. However, to truly get the most out of mutual funds—the most money and the most knowledge—you have to put the work in.
While investing in mutual funds is less risky than investing in stocks and bonds, it is in no way less complex. To succeed in mutual fund investing, you’ll have to keep some of the following things in mind:
- Check your mutual fund regularly, but not obsessively
- Remember, the money is in good hands, but you should still know what’s going on with your investments
- Do research when investing in or considering selling a mutual fund
- Compare any mutual fund you’re interested in with others in its peer group
- Do research and educate yourself about the advantages and disadvantages of specific mutual funds or similar products, such as exchange traded funds
If you can follow all of these tips and invest carefully, mutual funds are sure to be a lucrative and educational way for you to start your investing journey. Furthermore, they can be valuable to keep in your portfolio even as a much more experienced investor.