A mutual fund is created and managed by a fund manager to pool the money from many investors and invest it in a basket of stocks, bonds, or other securities. The benefit to the investor is that your money is managed by a professional in a portfolio that is diversified to reduce the risk.
This guide tells you more about mutual funds: what they are, how they work, where you can buy them, and why you might want to.
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Start Trading in 3 easy steps
1. Research the Markets
The first thing you should do is research the mutual funds market to find the funds you want to invest in based on their relative fees, risks, and potential return on investment.
2. Find a Broker
Next, find an online broker (if you don’t already have one) that offers the funds you want to buy and which charges low fees. You could open an account within minutes.
3. Deposit and Start Investing
Many brokers require a minimum deposit that you can pay by bank transfer, credit/debit card, or another method such as PayPal. Find the mutual fund you want to buy on the broker’s platform.
What Are Mutual Funds?
Mutual funds are “mutual” because they pool money from many investors who each own a slice of the several stocks or other securities that the fund invests in. You don’t own the constituent stocks directly, so you don’t get voting rights, but the fund manager will receive dividends that will be paid to you or reinvested on your behalf.
How Do Mutual Funds Work?
Mutual funds are created by a fund manager who manages the investments within the fund.
In an actively managed fund, the fund manager uses investment skills to decide which stocks or bonds to buy and when to buy (or sell) them. You will be charged a management fee for this professional management of the fund’s portfolio, and you hope to benefit from dividend income and capital appreciation in return. Since a mutual fund invests in several securities, it is inherently diversified, but the degree of diversification will depend on the fund’s objectives.
In a passively managed fund, the fund manager will buy all the stocks of a particular stock index such as the FTSE 100 index, in the right proportions to match the performance of the index as closely as possible. Because the fund manager adds less value by not skilfully picking the stocks, you will be charged a lower management fee for this kind of fund.
Unlike stocks or exchange-traded funds, mutual funds do not have a bid-ask spread between the buying and selling prices; you can buy or sell once per day at a single price that is known as the Net Asset Value (NAV).
Types of Mutual Funds
We have already said that there are actively managed and passively managed mutual funds. Funds may be further categorised by various criteria, and some online broker platforms let you filter their lists of available funds based on these criteria. Here are some of the common mutual fund categories:
- Equity funds invest in stocks but they may differ in terms of their investment approach and degree of diversification.
- Index funds charge lower fees for tracking a stock index such as the FTSE 100 or S&P 500 by buying all the stocks in that index.
- Fixed income funds invest in fixed income securities, which means government and corporate bonds.
Should You Invest in Mutual Funds?
Mutual funds are good investments if you don’t want to do your own stock picking, or don’t know how, and if you’re happy to entrust that stock picking to a trained professional.
If you don’t think that a professional money manager can consistently outperform the market, you can try to match the market at a lower cost via a passively managed index fund. You should be encouraged by the fact that legendary investor Warren Buffett describes index-tracking funds as the most sensible equity investments for most people.
Whether actively or passively managed, an index fund should provide a degree of diversification that would be difficult for you to achieve with separate stock investments unless you have a lot of money to invest.
From a performance point of view, nothing is guaranteed, but you can benefit from dividend income as well as capital appreciation.
Pros and Cons of Investing in Mutual Funds
Where to Start Trading Mutual Funds?
It is possible to buy mutual funds directly from the companies that create them, and this will cost you less than buying via a broker. However, a fund supermarket or brokerage platform will allow you to easily compare, buy, and sell mutual funds from many different fund managers, and you can see them alongside your other investments in stocks, bonds, and other assets.
Expert Tip for Buying Mutual Funds“ Rather than taking the dividend income from your mutual fund investments, it may be better to let the fund manager reinvest your dividends for compounded returns. Albert Einstein described compounding as the eighth wonder of the world. ”- Shams Ul Zoha
Top Mutual Funds to Invest In Right Now
Here are some suggestions for mutual funds you might buy. Think of them more as examples of the kinds of mutual funds you might invest in rather than concrete suggestions. Each one includes a rationale for why you might consider investing.
Vanguard Total Stock Market Index Fund (VTSAX)
Incepted in the year 2000, VTSAX is the world’s largest mutual fund, and one of the most well-run index funds. It provides diversification across the entire US stock market at a low cost. The expense ratio is 0.04%.
If you’d invested in this fund in February 2009, your investment would have increased sixfold (plus dividends) by July 2021 when it reached an all-time high price. This could be a good buy if you believe that the multi-year bull run in US equities will continue rather than reversing after the coronavirus pandemic.
Fidelity 500 Index Fund (FXAIX)
FXAIX tracks the US S&P 500 index with a low expense ratio of between 0.01% and 0.02%. The value of your investment in this fund would have tripled (excluding dividends) in the ten years since its inception in 2011. Like VTSAX, this fund is one to invest in if you believe that the US equities bull run will continue.
Fidelity Government Cash Reserves (FDRXX)
At the other end of the safety spectrum, the FDRXX fund invests in ultra-safe US Treasuries and other fixed-income securities, and it has an expense ratio of 0.26%.
This fund achieved an average annual return of just 0.44% in the ten years to July 2021. It won’t make you rich, but if you’re approaching retirement, it should at least preserve your cash if the stock markets crash.
Mutual Funds Summary
Mutual funds provide a passive investment option for amateur investors who don’t have the time or skill to pick stocks. You can entrust your investment decisions to a professional fund manager or let the fund itself make passive investments by replicating the returns of your chosen stock index. You won’t beat the market, but if the multi-year bull run from 2009 to at least 2021 is anything to go by, you’ll be happy enough merely matching the market.
Frequently Asked Questions
According to legendary investor Warren Buffett, index-tracking mutual funds are the best investment for amateur investors.
A mutual fund can only be bought or sold once per day at that day’s net asset value, which is calculated when the market closes. An ETF can be bought (at the “ask” price) or sold (at the “bid” price) at any time during market hours in the same way that you would buy or sell a single stock.
No. You can only place an order to buy or sell at the price that is calculated at the next valuation point. If you want to guarantee your entry price with a limit order or protect your investment from loss with a stop order, you’ll have to invest in an ETF instead.
No. Alternatively, you can buy mutual funds through other channels such as a fund supermarket or direct from the fund manager.
Almost. The fund manager does their best to match the reference index by buying the same stocks in the same proportions that are used to calculate the index. However, this process isn’t perfect.
Yes, mutual funds collect dividend payments from the constituent stocks and either return these dividends to you as income or reinvest the dividends on your behalf. You can achieve compounded returns by reinvesting dividends.