When you hear “mutual fund,” your eyes might glaze over, and your mind may start thinking about what pizza toppings you should order for dinner.
Some say that you can’t go wrong with cheese, but you find it a little lacking. You’re more of the Hawaiian, or better yet, veggie or meat supreme type.
As it turns out, your taste in pizza aligns with your investment style. Similar to turning up your nose to a lone topping, you eschew single stocks. You’re more interested in investments that consist of a combination of stocks and other investments, like mutual funds.
And you’re not alone. Americans have invested $22 trillion in mutual funds, making them the most popular type of investment.
While you don’t want to follow others’ investment strategies precisely, mutual funds are popular choice for a couple of reasons. This primer on mutual funds will get you in the know.
What is a mutual fund?
A mutual fund pools together money from thousands of shareholders in order to buy large blocks of stocks, bonds, and other securities with a common investing strategy. It’s typically too time-consuming and expensive to do this on your own, but mutual funds allow individual investors to get into the stock and bond markets and benefit from professional management.
Mutual funds exist for almost every investment strategy, from large-cap stocks (stock of companies worth more than $10 billion) to municipal bonds (a security that’s sold by a local municipality).
What is the biggest advantage of a mutual fund?
Someone trained in investing and finance professionally manages the money in mutual funds. Even better, analysts who devote their time to reading company reports, scouring balance sheets, and speaking with company management often aid these financial advisors in selecting which individual stocks and bonds the mutual fund should contain.
Mutual funds are common.
That’s because they make up workplace retirement accounts such as 401(k)s or 403(b)s. The vast majority of mutual funds can be a great way to save for your golden years because you’re investing small amounts at regular intervals, a strategy known as dollar cost averaging.
You can also buy shares of mutual funds for your individual retirement account (IRA) or taxable investment account.
What happens when you buy shares of a mutual fund?
Your money is instantly diversified, spread around to dozens, hundreds, or even thousands of securities. To put your money into so many different investments on your own would be cost prohibitive, not to mention impractical.
Mutual funds charge fees.
This is because managers and analysts must be paid for their work. Lucky for you, mutual fund fees have dropped in the past two decades. According to the Investment Company Institute, the average stock fund charges fees of 0.63 percent (down from 1.04 percent in 1996) and bond funds charge an average fee of 0.51 percent, a decrease from 0.84 percent 20 years prior.3
Make sure your mutual funds charge fees in line with these averages—or even less—so you can pocket more of your returns. In general, index mutual funds have lower fees than actively managed mutual funds because they are passively managed, meaning they have fewer transactional costs and you aren’t paying for an advisor’s expertise.
Now that you’re in the know, are you going to make mutual funds part of your investment strategy?