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Mutual Funds

What are mutual funds?

 

Mutual funds are investment vehicles that offer investors a means of pooling money to invest in an array of securities. By purchasing a share in a specific mutual fund, an investor then has a small stake in each of the assets invested within the fund. Shares of mutual funds are traded once a day after the markets close, unlike stocks and ETFs which are traded throughout the business day.

Mutual funds are advantageous because they can balance financial risk by investing in numerous assets at once, thus providing a diversified portfolio. 

 

How do mutual funds work?

 

Similar to ETFs, mutual funds are essentially a basket of securities. When you purchase a share in a mutual fund, you are therefore purchasing one share in the basket of assets held within the mutual fund and gain exposure to a myriad of investment options. You now have proportionate ownership in each of the assets held within the fund, and moreover, participate in all the gains and losses from each of the specific assets. 

In essence, the value of specific mutual fund shares is determined by the performance of the securities in it. These types of investment vehicles are beneficial because they provide diversification. Additionally, they also give the average investor access to the investment and money management skills of the fund manager tasked with allocating the fund’s assets to meet its investment objective. The investment objective of a mutual fund is always outlined in the prospectus, which is a document available to prospective investors disclosing pertinent information about the operation of the fund.

Investors gain a return from a mutual fund through 1) distributions, 2) capital gains from the securities held within the fund if they are sold, or 3) selling shares of the fund if its market value increases.

Although mutual funds provide investors with an affordable means of diversification, it is important to note that all mutual funds come with fees. When researching prospective mutual funds to invest in, always pay close attention to the fees that are associated with each fund.

 

Types of Mutual Funds

 

Mutual funds are categorized by the securities held within the specific fund. Additionally, they may be sub-categorized depending on the particulars outlined in the fund prospectus. Depending on your preference and investment goals, there are an array of mutual funds available to investors. Below are some examples:

 

Equity Funds – Also known as “stock funds”, these primarily invest in common stocks. This category of mutual fund comprises the largest number of available funds on the market today. Equity funds offer higher returns, but likewise increased risk.

 

Bond Funds – Also known as “fixed-income funds”. These invest solely in fixed-income securities be they government bonds like US Treasuries, corporate bonds, or municipal bonds, etc. These types of mutual funds are designed to generate returns from interest on the debt securities. They are sub-categorized based on the types of debt securities held within the fund. Although considered safer than equity funds, depending on the debt securities invested within the fund, they can still be a higher risk investment option.

 

Money Market Funds – These funds invest solely in short-term, high-quality debt securities in the money market. These types of funds are considered one of the safest investment options for investors. They offer the lowest returns out of all mutual funds, however, come with the lowest risk of losing one’s principal.

 

Index Funds – These funds are designed to track the performance of indexes such as the S&P 500. They have gained in popularity because they simply mimic a specific index and therefore require little management by a fund manager. Thus, index funds can provide diversification with typically lower fees and higher returns.

 

How to Invest in Mutual Funds

 

First, you must determine your investment goals and your budget for investing in mutual funds. Likewise, you must decide whether you want actively managed (managed by professional money managers with the intent of beating the market), or passively managed (mimics the market) mutual funds. Next, choose where you will purchase the mutual funds – for instance, via an online brokerage. Many popular online brokers offer a wide selection of funds, in addition to research tools. Then, you must thoroughly research and review the prospectus of prospective mutual funds, including the expense ratio (amount of a fund’s assets is used for operational expenses) and any transaction fees, before investing your money. 

 

Best Mutual Funds Currently Available on the Market

 

Here are examples of some of the best mutual funds currently available on the market, based on performance, low expenses, and diversification.

 

Fidelity Advisor Growth Opps Z (FZAHX) – This is one of the best performing US equity funds available to investors. It is actively managed with an expense ratio of 0.72% and a year-to-date (YTD) return of 37.73%. There is no minimum initial investment for this mutual fund.

 

Vanguard 500 Index Fund (VFIAX) – This is one of the most popular index funds available on the market. It has an expense ratio of just 0.04% with an initial minimum investment of $3,000.

 

Vanguard Total Bond Market Index Fund (VBTLX) – This bond fund offers diversification with a low expense ratio of 0.05% and an initial minimum investment of $3,000.

 

Popular Mutual Fund Brokers

 

Investing and trading in mutual fund shares through a brokerage firm is an easy option for investors. Because there are numerous brokerages, the choices can be a bit overwhelming, especially for beginners. Here are some of the most popular and respected mutual fund brokers.

 

Vanguard Mutual Funds

 

Vanguard mutual funds are a popular choice for investors who want an array of mutual funds to select from depending on investment goals. Vanguard offers a wide range of money market funds, equity funds, bond funds, and was the first company to introduce index funds to the market. 

 

Fidelity Mutual Funds

 

Fidelity mutual funds are another excellent option for investors who want exposure to some of the top performing mutual funds on the market. Likewise, you have access to exceptional research tools to help assist in your selection of the thousands of funds offered by Fidelity.

 

Charles Schwab Mutual Funds

 

Charles Schwab mutual funds come in a myriad of equity, bond, and asset allocation funds. Through their Mutual Fund OneSource® service, investors can research thousands of available funds with no loads (no commission or sales charges) and no transaction fees.

 

Mutual Fund Calculator

 

Use this Mutual Fund Calculator to determine how much the expense ratio of a specific fund will impact on long-term returns. It is important to note that this calculator is applicable only for no-load, no-transaction-fee mutual funds.

 

Comparison Table On The Different Types Of Trading

 

Here is a comparison table examining the different types of trading.

 

Type of TradingBest Suitable ForRisk vs. Potential ReturnControl Over InvestmentsResearch and Legwork Needed
OptionsActive TradersLower-level Risk
(When Done Correctly)
The investor has complete control over which companies are selected, and what options contracts are chosen.All research and trading is done by the investor.
StocksBeginners and Long-term InvestorsHigh risk, yet has the potential for larger gainsThe investor has direct control over all invest decisions.All research and trading is done by the investor.
ETFsBeginners and Long-term InvestorsLower-level RiskProfessionally managed investment vehicle. All research and trading is done by a financial professional. Investors are charged a fee called an "expense ratio".
BondsBeginners and Long-term InvestorsLower-level RiskIf investing in individual bonds (rather than bond ETFs) the investor has direct control over all invest decisions.All research and trading is done by the investor, if investing in individual bonds.
Mutual FundsBeginners and Long-term InvestorsLower-level RiskProfessionally managed investment vehicle. All research and trading is done by a financial professional. Investors are charged a fee called an "expense ratio".
FuturesActive TradersMedium-level risk (when done correctly)The investor has complete control over which futures contracts are chosen.All research and trading is done by the investor.
Swing TradingActive TradersHigh risk, yet has the potential for larger gainsThe investor has direct control over all invest decisions.All research and trading is done by the investor.
Day Trading Active TradersHigh risk, yet has the potential for larger gains if done correctly.The investor has direct control over all invest decisions.All research and trading is done by the investor.
Commodity TradingBeginners and Active TradersHigh risk, yet has the potential for larger gainsThe investor has direct control over all invest decisions.All research and trading is done by the investor.
Trend TradingBeginners and Active TradersHigh risk, yet has the potential for larger gainsThe investor has direct control over all invest decisions.All research and trading is done by the investor.

 

Mutual Fund FAQs

 

Investors gain a return from a mutual fund through 1) distributions, 2) capital gains from the securities held within the fund if they are sold, or 3) selling shares of the fund if its market value increases.

Mutual funds are categorized by the securities held within the specific fund. Additionally, they may be sub-categorized depending on the particulars outlined in the fund prospectus. Depending on your preference and investment goals, there are a variety of mutual funds available to investors including:

Equity Funds - Also known as “stock funds”, these primarily invest in common stocks. This category of mutual fund comprises the largest number of available funds on the market today. Equity funds offer higher returns, but likewise increased risk.

Bond Funds - Also known as “fixed-income funds”. These invest solely in fixed-income securities be they government bonds like US Treasuries, corporate bonds, or municipal bonds, etc. These types of mutual funds are designed to generate returns from interest on the debt securities. They are sub-categorized based on the types of debt securities held within the fund. Although considered safer than equity funds, depending on the debt securities invested within the fund, they can still be a higher risk investment option.

Money Market Funds - These funds invest solely in short-term, high-quality debt securities in the money market. These types of funds are considered one of the safest investment options for investors. They offer the lowest returns out of all mutual funds, however, come with the lowest risk of losing one’s principal.

Index Funds - These funds are designed to track the performance of indexes such as the S&P 500. They have gained popularity because they simply mimic a specific index and therefore require little management by a fund manager. Thus, index funds can provide diversification with typically lower fees and higher returns.

Choosing mutual funds is solely dependent on individual investment goals and level of risk aversion. Once these two components have been determined, an investor must thoroughly research and review the prospectus of any prospective mutual fund, prior to investing. In addition, it is important to always pay close attention to the fees that are associated with each fund.

Index funds have become increasingly popular because they offer a low-cost means of diversification with low risk. These types of mutual funds passively track the performance of indexes such as the S&P 500, so they typically have low expense ratios with higher returns.

Some of the top-performing equity funds available to investors based on year-to-date returns and low expense ratios include: 

Fidelity Advisor Growth Opps Z (FZAHX) with an expense ratio of 0.72% and a (YTD) return of 37.73%.

Delaware Smid Cap Growth Institutional (DFDIX) with an expense ratio of 0.85% and a (YTD) return of 47.1%.

American Century Focused Dynamic Growth Investor Class (ACFOX) with an expense ratio of 0.85% and a (YTD) return of  45.5%.

JPMorgan Large Cap Growth R5 (JLGRX) with an expense ratio of 0.54% and a (YTD) return of 34.6%.

Hartford Growth Opportunities HLS IA (HAGOX) with an expense ratio of 0.65% and a (YTD) return of 39.2%.

Exchange-traded funds (simply referred to as ETFs) are investment vehicles that are comprised of a collection of assets like stocks or bonds and are traded on an exchange. Similar to ETFs, mutual funds are essentially a basket of securities. When you purchase a share in a mutual fund, you are therefore purchasing one share in the basket of assets held within the mutual fund and gain exposure to an array of investment options. 

A mutual fund and an ETF are similar in that they are both investment pools. However, ETF shares are traded throughout the business day on exchanges, akin to stocks. Conversely, shares of mutual funds are traded once a day after the markets close.

Stocks are securities that represent fractional ownership in a single company. By purchasing stocks, an investor is buying a portion of a specific company, and therefore entitled to a fraction of said company’s earnings in the future. These specific fractional portions of a company are deemed “shares”. By buying shares (or stock, as it were) in a company, the investor becomes a “shareholder” in the company. The two principal forms of stock are “common” and “preferred”.

Common Stock - This form of stock gives the shareholder the right to vote on the corporate policy of the specific company, and elect members to its board of directors.

Preferred Stock - This form of stock contains all the characteristics of common stock, but is classified as “nonvoting” (meaning the shareholder cannot vote on corporate policy, or elect members to a board of directors). However, it offers more financial benefits and protection to the shareholder. For instance, preferred stocks provide guaranteed income by paying dividends at regular intervals. Additionally, in a liquidation preferred stockholders take precedence over common stockholders, by receiving assets first.

Mutual funds are investment pools that enable a large number of investors to invest in a basket of securities. When you buy shares in a mutual fund, you are therefore buying shares in each of the securities held within the specific mutual fund. Therefore, you diversify your portfolio by gaining exposure to a myriad of assets with one investment. Moreover, you now have proportionate ownership in each of the assets held within the fund, and participate in all the gains and losses from each of the specific assets. However, mutual funds do not offer voting rights.

Shares of mutual funds are traded once a day after the markets close, unlike stocks and ETFs which are traded throughout the business day.