The Basics Of Investing In Mutual Fundsby Preston Davis Aug 08, 2022
It happens to many people: They suddenly realize that they’re investing way too much time thinking about investing. Savings accounts aren’t particularly rewarding. Stocks can seem scary. And crypto feels like it’s just too much of a risk, especially recently.
But if you’ve been racking your brain reviewing one too many investment options, you might want to consider mutual funds. Read on to learn why this investment opportunity might be the right choice for meeting your financial goals — without adding to your level of anxiety.
Simply put, a mutual fund is a group of investments bundled together into packages. Fund managers oversee the investments and pool your money along with other investors’ contributions to buy bonds, stocks, and other financial assets to build a portfolio. The benefit? You won’t be relying on one or two stocks to pay off; instead, your portfolio will offer diversified financial opportunities right from the start.
There are a few different types of mutual funds. These include fixed-income funds, hybrid funds, equity funds, and index funds.
Fixed-income funds invest in securities that will pay you and your fellow investors on a consistent, or fixed, basis. While this type of fund doesn’t offer a big windfall, you can earn a stable and reliable income. Fixed-income funds are a good choice if you’re looking to avoid any sudden plummets in your portfolio or if you’re looking to add stable income to your retirement savings.
Fixed-income funds include:
- Bond Funds – This type of bond invests in government and corporate debt; to that end, a bond is essentially a loan, with you collecting the interest. Don’t expect a high rate of return, but it’s often a better option than stashing your cash in a bank account.
- Money Market Funds – If you’re looking to invest in reliable, short-term debt, consider U.S. Treasury bonds or a certificate of deposit (CD). Both options are considered some of the safest investments on the market.
- High-Yield/ “Junk” Bond Funds – With this type of fund, investors assume debt from borrowers who are at risk of defaulting on their loans. You’ll be rewarded with more money in interest for accepting the danger of default.
Additionally, funds are available that focus on specific debt types, including foreign bond funds, corporate bond funds, municipal bond funds, and mortgage funds.
Hybrid funds offer additional options for investors looking for the middle ground in terms of risk. These include:
- Target-Date Fund – Your portfolio will gradually shift from products focused on growth through stocks to bonds with stability as you near retirement.
- Balanced Funds (Asset Allocation Funds) – If you’re looking to create a portfolio that blends stable income and growth potential, balanced funds might be for you. They usually boast a fixed ratio; for example, 40% of your money might be in bonds and 60% in stocks.
- Blended Funds – These equity funds offer a mix of value stocks and growth. If you’re looking for reliable payouts, consider growth-and-income funds.
Investing in an equity fund means your money will go primarily to stocks affiliated with publicly traded companies. Equity funds are more like stocks in that they offer higher growth potential, but they also come with more risk. In general, equity funds may be a good choice for younger investors as they’ll have more time to recover their investment should a sudden financial downturn occur.
Equity funds are often described by the size of the companies they invest in, with the term “cap” used to refer to market capitalization (total value of the companies’ outstanding shares).
Cap labels refer to the worth of the companies’ shares and include:
- Nano-cap Shares worth less than $50 million
- Micro-cap Shares worth between $50 million and $300 million
- Small-cap Shares worth between $300 million and $2 billion
- Mid-capShares worth between $2 billion and $10 billion
- Large-capShares worth more than $10 billion
Equity funds are also classified based on investment strategies, such as value funds and growth funds.
Value funds refers to stocks and other securities that fund managers believe are undervalued. Often regarded as bargains that come with lower risk and lower fees, value funds may grow in the long run and eventually pay reliable dividends. In contrast, growth funds invest in rapidly growing companies, and fund managers plan on selling these stocks for more money than they originally cost. This type of buying and selling, however, can come with higher fees. There’s the potential for investors to make more money – and to do so quickly – but the unpredictability of the market can dash hopes of a definite windfall.
In general, index funds result in a portfolio that mimics a financial market index. A good example of this is the S&P 500, which is an index that tracks the stock performance of 500 large U.S. companies. Fund managers attempt to match the performance of an index by purchasing stocks in a wide range of companies listed in that particular index. It stands to reason that if an index you’ve invested in is performing well, your portfolio will benefit. The list of companies included in an index doesn’t change frequently, which results in low operating costs when it comes to index fund investing.