Five Things Everyone Should Know About Investing in Mutual Funds

Five Things Everyone Should Know About Investing in Mutual Funds

Not everyone needs to know everything. I have an uncle who was recently honored as a university fellow at Lakehead University (Congratulations, Uncle John). He specializes in the study of Banach spaces and abstract convexity. Now I have no idea what any of that means and furthermore have no idea how someone can specialize in it. So I am glad that I don't need to know that. But, in the field of math I do need to know how to add, subtract, multiply, and divide. No everyone needs to know everything, but life is a lot easier if you at least know some minimal facts about important things. So here are the five things I think everyone should know about investing.

1. What is a mutual fund?

Mutual funds are places where a group of investors (everyday folk like you and me) pool their money. Due to minimums or fees an individual investor might be limited to buying only a few stocks. When your investments are so concentrated, any poorly performing stock can have a dramatically negative impact on your losses. Some mutual funds can be purchased with as little as $500 and give you ownership of hundreds of stocks. Mutual funds have different goals and focuses depending on how they choose to invest. The greatest advantage of mutual funds is that your money is spread out between many different stocks.

2. What do the terms 'large cap', 'small cap', 'value', 'growth' and 'international' mean?

Not all mutual funds are equal. They have different purposes. Some will invest in bonds, others in specific sectors of the economy. Some mutual fund companies invest primarily in big companies. Others in small companies. Some might do a little of everything. It is crucial that you know the 'categorization' of your mutual fund as that has the greatest impact of your expected risk and return. Small cap(italization) mutual funds basically invest in smaller companies. These stocks provide a lot more opportunity for quick growth as smaller can grow twice as big, twice as fast. On the other hand, because they are smaller there is a lot more opportunity for failure. Large caps focus on bigger companies. They would buy stocks from places you have heard of like Wal-Mart, Exxon, and General Electric. These companies are established and might be expected to provide steady results, but likely will not provide a surge of gains or losses.

Growth and Value refer to the style the fund manager prefers for buying stocks. Value managers look for great stocks that for some reason or another seem to be under priced. In the mall they would be the ones looking through the50% off rack. Growth managers, however, buy stocks that are performing well. The stock has posted positive results so they buy these stocks with the expectation that the growth will continue.

International funds will typically buy stocks that are owned by companies that are either owned or operated outside the United States or the home country.

3. What are mutual fund management fees?

Someone out there is managing your money. They are deciding which stocks to buy and which to sell. They take a salary. They have people who do research and analysis. They get paid. They send out information and furnish offices. Some pay for advertising. Who pays for it all? You do - the mutual fund investor. It is easy to find out what you will pay when you get a prospectus. They will tell you the percentage they charge in fees. They will also show you how much that would be in actual dollars based on a preset dollar investment. Always remember: when it comes to fees they are always included when you see their performance. In other words, at the end of a trading day when a mutual fund posts their returns, all fees have already been accounted for.

Mutual funds structure their fees in different ways. One way that funds earn money is by charging a load. For example, a fund might charge a 5% front end load. That means when you give them $1,000 they will take $50 as their fee and invest $950. A back end load is a fee that is assessed when you take the money out. If a company has a back end load of 1% and you withdraw $1000 you will pay $10 towards the load fee and they would give you $990. No load funds will invest the full amount. No load funds will typically have higher management fees.

4. What is a prospectus?

A prospectus is an introductory booklet. Much of the information will seem dry and useless. This is because prospectuses are written for lawyers as much as buyers. However, the prospectus will introduce you to the management style. From that style you can get a good idea at the level of risk you are assuming.

5. Where can I buy a mutual fund?

Mutual funds can be purchased directly form the organization (fund family) who oversees the fund. These days you can just get online and view all the important information. That organization will only sell their own brand of funds.

You can also purchase funds through an online brokerage firm. A brokerage firm will allow you to purchase mutual funds from any fund family they have access to. You are not limited to only one fund family.

You can also purchase mutual funds through a financial advisor who works either independently or for a brokerage firm. Your advisor will suggest funds, and make purchases on your behalf (with an extra layer of fees).

Craig is a Christian, missionary, family man, traveler and blogger. He writes a blog on personal finance from a Biblical perspective at http://www.moneyhelpforchristians.com.

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