Investing in mutual funds is probably one of the fastest and easiest thing you can do today to help you achieve your financial goals in the future — especially if you are already debt-free.
Mutual funds offer much better growth rate compared to your savings account, where your money loses value to due inflation rates.
Although investing in mutual fund is quite a walk in the park, it doesn’t mean you just buy into the first salesman who gets to introduce you his product.
We’re here to give you a walk through of some easy concepts you need to understand first before investing in a mutual fund.
Terms You Need to Know Before You Start Investing in Mutual Funds
What is a Mutual Fund?
A mutual fund is made up of a pool of funds collected from investors such as you, your neighbors, and over 80 million of Americans. The pooled funds, in billions perhaps, are invested in securities such as stocks, bonds and other asset types.
Mutual fund managers invest the fund to attain capital gain for investors — yes, including you. Each fund has different objectives which are reflected on each portfolio.
Mutual Fund Concepts
NAV or Net Asset Value, means the price per share of the mutual fund which you own. NAV is calculated every day, at the close of trading session, by the mutual fund company and it is the price at which the funds are bought and sold. For example, as of April 17, 2014, Vanguard 500 (a name of a mutual fund) is sold at $172.08 per share.
Net Asset Values fluctuate: when it goes down, you will see a “loss” in your account; when it goes it up, you’ll see “gains.” But remember that losses and gains are only realized when you actually sell shares of your mutual fund. So sit back and relax…you are in for the long haul.
Some mutual funds ask for sales charge or “loads” and are therefore called “load funds.” Loads can either be front-end or back-end. Front-end loads are paid up front on the day you buy shares from your mutual fund, usually about 5%. Back-end loads, on the other hand, are paid when you sell your mutual fund shares.
Note: It’s better to choose a mutual fund that has no sales charge (“no-load fund”) but it’s not the only factor you should be looking at.
Basic Fund Types
Mutual funds are invested in different asset types, hence, the different types of mutual funds. Some of the common types are the following.
An equity is an asset type more commonly known as stocks, which are bought and sold in stock exchanges like the New York Stock Exchange (NYSE). A mutual fund that invests in equities or stocks are therefore called equity funds (or stock funds). Because investing in stocks involve higher risk, equity funds are considered to have the highest risk among the different fund types but offer the highest returns.
Bond funds are mutual funds primary invested in bonds. A bond is a debt security, where an investor (bond holder) lends money to a borrower (bond issuer) for a defined time period at a specific interest rate, through which the bond holders achieve their capital gains. As they are considered fixed security asset, bonds typically carry lower risk and therefore lower gains than equities.
Balanced funds are simply mutual funds whose portfolio components are a mix of equities or stocks and bonds and other asset types. What these components are depend on the investment company and the fund managers. Balanced funds tend to balance out the risks involved among the different asset types.
An index fund is a type of mutual fund whose portfolio is designed to match the components of a stock market index. One example of a market index is the S&P 500, which is based on 500 large companies traded in the NYSE or NASDAQ. Many people invest in index funds for their low fees and exposure to a range of reputable and profitable companies.
Capital Appreciation: How You Can Gain from Mutual Funds
Your gains depend on capital appreciation, or the difference between the price at which you bought your mutual fund shares and the price at which you sold it. Like many other investments, returns or gains are not always an assurance. Markets experience highs and lows. It is not uncommon, however, to hear many people say that mutual funds have an annual average of 12% return. Again, there is no assurance.
Knowing your gains from mutual funds is as simple as looking at the change in share prices or Net Asset Value of your fund. When you open a mutual fund account, you will typically have an online access to your account where you can see a summary of your capital gains. Mutual funds, however, are designed for the long term investor so this is something you should not be doing on a daily basis. Nor should you be selling your mutual fund shares as soon as you see some gains!
Perhaps the biggest benefit mutual funds can give you is having a fund manager to take care of your money and the risks involved in investing. Fund managers are experts who can take away the hassle and technicalities of investing DIY style. They deal with graphs, numbers and market trends and if you are too busy with your career which is your main source of income, then you probably won’t have much time for that. A mutual fund therefore is a good investment choice — a must-have for your wealth-building portfolio.