What Are Mutual Funds And How Do They Work?
A mutual fund is an investment tool, comprised of money collected from investors for the purposes of investing in securities such as stocks, bonds, money market instruments, and other assets. Most mutual funds invest in a large number of securities, allowing investors to diversify their portfolios at a low cost. They are usually managed by a team of investment pros.
Mutual funds are priced by shares, and the price per share, also known as a fund’s net asset value (NAV), is based on the value of the securities contained in the portfolio at the end of each business day.
Here we’ll discuss how mutual funds work to help you decide if these types of investments make sense to your portfolio.
- How do mutual funds work
- Steps to get started with mutual funds
- What are the different types of mutual funds?
- Advantages and disadvantages of mutual funds investing
- Can you lose money in a mutual fund?
- Get started investing in mutual funds with Northvale today
1. How do mutual funds work?
A mutual fund is a type of pooled investment fund in which many people own shares. Mutual funds invest in many different companies; some even invest in the entire stock market. However, when you buy shares in a mutual fund, you don’t invest in those companies directly since you own shares in the fund, not in the companies the fund selects.
For example, imagine you invest in a tech-heavy mutual fund. That mutual fund pools the money from all its investors and invests in a number of companies. Therefore, while the fund likely invests in companies such as Amazon and Microsoft, you don’t own shares in those companies. Instead, you simply own shares in the mutual fund.
The share price fluctuates based on the net asset value (NAV) of all of the mutual fund’s assets. NAV is calculated by dividing the total value of a mutual fund’s assets (less liabilities) by the total number of shares outstanding. Thus, changes in the share price don’t reflect fluctuations in the value of a single company, but instead they reflect the net change in all of the companies in which the fund invests.
You can buy shares in a mutual fund from whichever brokerage you prefer. However, employer-sponsored retirement plans largely invest in mutual funds, so you may be invested in them without even realizing it.
Unlike ETFs, mutual funds can only be traded once per day, after the market closes at 4 p.m. eastern. Because of this, the price of mutual funds doesn’t change throughout the day; it only changes once the NAV settles after market close.
2. Steps to get started with mutual funds
Here are some steps to get started with mutual funds:
- Research mutual funds. There are many different types of mutual funds, including those with broad exposure and those that cover a narrower niche. Thus, you’ll want to find funds that suit your strategy.
- Decide where to buy. Our Northvale eTrading platform offer mutual funds; you must simply decide and ready to get started. We offer no account opening maintenance charges. Calculating your mutual fund fees is also a good idea.
- Deposit funds and buy. After you’ve done your research, take a simple step: just transfer money in and buy the shares you want.
- Manage your portfolio. Once you’ve bought your shares, there isn’t much work to do with mutual funds. However, periodic rebalancing is a good idea if you have multiple funds.
3. What are the different types of mutual funds?
Mutual funds come in a variety of forms. Investors have various goals; thus, different mutual funds invest in different types of securities. Here, we will cover some of those most common types of mutual funds.
- Equity funds: This type of mutual fund owns shares of stock in public companies. These funds invest in equities, which is another name for stocks. Within equity funds are small-cap funds, large-cap funds, value funds, growth funds, and more.
- Index funds: Rather than try to beat the performance of the overall market, index funds aim to simply match the performance of a given index, such as the S&P 500. This strategy requires much less research and analysis than funds that attempt to beat the market, leading to lower fees. Those lower fees have made these funds increasingly popular over the past several years.
- Money market funds: Short-term investment vehicles that usually invest in much safer securities than equity funds and index funds, and they can invest in high-quality, short-term debt issued by corporations and government entities. Money market fund investors are seeking capital preservation above all else.
- Fixed-income funds: They invest in government bonds, corporate bonds and other securities that pay a set rate of return. Typically, they are actively-managed and their portfolios can change frequently. Although they pay a set rate of return, some bonds can have high levels of risk, which can hurt returns.
- Balanced funds: These funds invest in a portfolio of both stocks and bonds. They aim to reduce risk by providing exposure to a variety of asset classes.
- Target date funds: These funds are designed for retirement investors and generally have a “target date” year when holders are expected to retire. They hold a mix of stocks, bonds, and other securities. Over time, the portfolio shift its allocation from riskier investments to safer investments.
4. Advantages and disadvantages of mutual funds investing
Advantages:
There are several advantages of mutual funds which have led to their widespread popularity. Convenience, professional management, and diversification are some of the biggest advantages. If you want to know how to pick the best mutual funds, look for them to hit on all of these points.
- Convenience
Mutual funds make it very easy to invest. You can hold them in a number of different accounts, including employer-sponsored retirement accounts, an individual retirement account (IRA), or in a brokerage account. All you’ll have to do is place an order for the number of shares you want to buy and wait for the order to be filled at the end of the day.
- Built-in diversification
Mutual funds have built-in diversification, making them a less volatile investment. They invest in a large number of companies, greatly lessening the impact of any one company performing poorly or even failing. Thus, they tend to have strong performance without excessive risk.
Some of the largest mutual funds, such as FXAIX, VFINX and VTSAX, are index funds. These funds aim to track the performance of an index, such as the S&P 500.
- Professional management
When you invest in mutual fund, you don’t have to worry about constantly buying and selling securities. Instead, the fund manager does all of the work for you. If you automate your investing strategy, there will be very little time spent managing your portfolio.
- Profit reinvestment
Another benefit of mutual funds is profit reinvestment. For example, if a mutual fund pays out dividends or capital gains, that money can usually be reinvested without any fees. And this can all be done without any input from the investor.
Disadvantages:
Although mutual funds have many advantages, they have their share of disadvantages, too.
- High fees
One issue many holders of mutual funds face today is high fees. While mutual funds do quite a bit to help their investors, fees can be excessive in some cases. Some mutual funds have expense ratios of 1 percent or more. That may not sound like a large percentage, but it can cost some investors tens or even hundreds of thousands of dollars in their lifetimes. On top of that, the broker may charge you to buy or sell the fund, and some fund companies even hit you with a commission that could be 1 or 2 percent of the total investment, or what’s called a sales load.
Conversely, there are many index funds available with very low fees or no fees at all, allowing investors to build portfolios with a few funds for a very low cost.
- Uncontrollable tax events
Investors don’t have to worry about buying and selling securities all the time when they invest in mutual funds. That usually means a lot less work is needed from the average investor. But when a mutual fund sells securities from the portfolio, it may lead to year-end distributions to investors. These distributions are taxable investment income.
These distributions are taxed at either ordinary income or capital gains rates, depending on how long the fund held an investment, which means you might be left with a higher-than-expected tax bill at the end of the year. Those in high tax states may want to pay special attention to this issue, since it can eat away at your gains.
- No intraday trading
Unlike stocks and exchange traded funds (ETFs), mutual funds are only traded once per day. That happens after the market closes at 4 p.m. Eastern time. While this is not a huge problem for passive investors, it could mean there is a different order price than you expect if you place orders manually.
5. Can you lose money in a mutual fund?
Yes, you can lose money in a mutual fund. If the investments held in the fund decline, the mutual fund itself will also lose value. The mutual fund holds the assets that you’re investing in and its performance will depend on the performance of those stocks or bonds. Mutual funds that track broad market indices such as the S&P 500 have strong long-term track records, however. Investors in these funds have earned about 10 percent annually over the long-term.
6. Get started investing in Mutual Funds with Northvale today
Northvale offers custody, depository, and brokerage services, including offshore vehicles covering all types of financial instruments and underlying assets.
Our eTrading platform allows you to access directly on over 3 million ISINs (International Identification Number) on 60 stock exchanges and OTC in funds, stocks and ETFs.
When choosing what to invest in, you’ll want to gauge what will have the lowest fees, most diversification, and best performance over time. Which our services allows you to keep control and maximize your investment services. And get the best available products, rates, services, and technologies for you.
