Learn About Mutual Funds
An Introduction
You made a good decision when you decided to learn about mutual funds. Mutual funds are the best way for you, as an individual investor, to invest in stocks, bonds, real estate, precious metals, commodities and cash. Yes, cash too, through money market mutual funds. You'll find this section to be an excellent introduction to mutual funds.Mutual funds offer some very compelling benefits that make them an ideal investment vehicle for any individual investor. Even some institutional investors make use of these investment vehicles. Given their credentials, what these professional investors know about mutual funds should carry considerable weight in your evaluation of these investment vehicles. The same features that make mutual funds appealing to institutional investors will serve you well, too. Mutual funds provide the following benefits:- Automatic diversification at various levels.
- Access to financial markets worldwide.
- Access to all major asset classes.
- A broad selection of fund types.
- A diversity of investing styles.
- Professional management.
- Elimination of the need for individuals to perform detailed and ongoing securities analysis.
- The option of making automatic investments and withdrawals.
- Many funds can be purchased with small initial and subsequent investments.
- No transaction fees, if you pick the right place to open your account.
- No sales commissions if you choose no-load mutual funds or invest through a retirement plan that offers no-load funds.
Mutual funds are large, diversified portfolios of securities selected by skilled securities analysts and managed by highly qualified investment professionals. The money used to purchase the securities is raised by selling shares of the mutual funds to investors.Shares of mutual funds are similar to shares of common stock in that they represent the ownership of a piece of the fund. However, the formation of mutual funds and the pricing of their shares is much different than that of a regular corporation. This an important part of what you'll learn about mutual funds and you'll learn even more in the following subsection. Mutual fund shares are bought and sold at their net asset value (NAV). As with any security, you can expect your funds' share prices to fluctuate after you purchase the shares. Unlike other types of securities, mutual fund share prices are determined solely by the market prices of their underlying assets.Due to their nature and the means by which mutual funds are priced, your perception of their prices and your response to fluctuations in their prices should be different than your perception of and response to the prices of individual stocks and bonds. This is attributable to the fact that the number of mutual fund shares varies with demand, thus ensuring that price is determined solely by NAV. This seemingly subtle difference is another important aspect that you'll learn about mutual funds.The prospectus provides basic information about a fund, including the fund's objectives, what kinds of securities it can invest in and in what proportions, all the various fees charged to investors, past performance, and the fund's management. There's a lot to be learned about mutual funds in their prospectuses.For virtually every load mutual fund there is a no-load mutual fund that is equal in every way, or even better than, the corresponding load funds. If you are not receiving something of value in return for the load, then there is no good reason to pay the load.A load is a sales commission and usually runs about 5% of the amount you pay for shares of a load mutual fund. However, only 95% of the money you pay is actually invested, so you automatically suffer a 5% loss right out of the starting gate. Owning a portfolio of stocks and bonds that is large enough to be appropriately diversified is beyond the means of most investors. But even the wealthiest investors can benefit from the diversification and cost efficiency of mutual funds. What you'll learn about mutual funds will make this perfectly clear.How are mutual funds bought and sold?Shares of mutual funds can be bought and sold directly through the companies that manage the funds, or through discount or full-service brokers. You should never be charged a transaction fee when you deal directly with a company that manages a fund. You may have to pay a small transaction fee if you trade through a discount broker. You will pay a full commission if you trade through a full-service broker.Automatic investments and withdrawals are an option available with many fund companies. However, these options require establishing an account with the fund company. Additional information can be found above under The Prospectus and Mutual Fund Prices. ETF stands for Exchange Traded Fund, which is an investment company that owns a pool of securities that form the underlying value of the fund's shares and whose shares are traded like shares of common stock. The primary advantage of ETFs over regular mutual funds is that investors can exercise more control over the timing of capital gains and the incurrence of the associated tax liability. This advantage makes ETFs an appropriate alternative to regular mutual funds for some investors. What are closed-end funds?Closed-end funds are funds with a fixed number of shares that trade just like common stock. A closed-end fund's shares trade at whatever investors are willing to pay at any given time. So investors' perceptions of the aggregate value of a fund's assets determines price, rather than their net asset value (NAV). Closed-end funds often trade at a discount or premium to their NAV, which can present opportunities to knowledgeable, active traders. No amateurs, please!Given the way they are structured and sold, closed-end funds bear more resemblance to conglomerate corporations or holding companies than mutual funds. Therefore, there will be no further discussion of them on this site. Are hedge funds mutual funds?No! Absolutely not! The only similarity is that hedge funds invest pools of money provided by passive investors. (Here, passive means that the investors do not participate in the investment decision-making process or management of the fund.)The original purpose of hedge funds was to provide a market-neutral investment vehicle for wealthy investors as a hedge against large market fluctuations, thus their name. However, due to the fact that they are subject to very little regulation and oversight, many no longer do any hedging and instead take advantage of the dirth of regulation to invest in whatever they want. Currently, true hedge funds are very few in number. Unlike hedge funds, mutual funds are subject to very stringent guidelines defined by securities laws and enforced by the SEC. These guidelines include, but are not limited to, investing within the usually narrow and conservative confines of the objectives and constraints stated in the funds' prospectuses, operating in a very transparent manner, and not investing in harebrained schemes that could reap high returns at great risk to investors' capital. Due to their inherent risks, in particular the lack of regulation, hedge funds are only available to high net worth individuals. Given that, and the fact that they bear little resemblance to mutual funds, there will be no further discussion of them on this site. Before you move on to other sections...Be sure to spend enough time reading this introduction to mutual funds to learn the basics about mutual funds before you take the plunge. Click on the highlighted headings above to learn all about mutual funds.Return to the top of About Mutual Funds.
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