What you need to know before you Buy Mutual Funds

Before buying mutual funds there are two key things to understand. Firstly, you need to know what mutual funds are. What possibilities for investment exist? Secondly, you need to think through your goals in wanting to buy in to mutual funds. Why do you want to do it? Are you in it for short-term gain or long-term security? These are the kinds of questions you need to ask yourself before deciding. But what are mutual funds?

Mutual funds are a method of collective investment where a fund manager uses money pooled from many investors to trade in stocks, bonds, and securities, and then collects and passes on any income obtained through dividends or interest. There are currently over 8600 mutual funds belonging to the national association called the Investment Company Institute, with over $9.2 trillion of assets.

There are many securities available to invest in with the most common being cash, stock, and bonds. There are many different areas that could be specialized in. You might want to focus on technology industry stock funds, for example. Bond funds can vary according to their risk, the type of entity issuing the bond, or the maturity of the bonds. The fund manager will continually adjust the investment portfolio to achieve the stated aims of the fund.

Mutual funds are open-ended, which means that shares are issued to investors and bought back from them at the end of each day. They can be structured as either corporations or business trusts. Equity funds are the most common type of mutual funds, dealing mainly in stock. Growth funds look for capital gains whilst value funds are aimed at getting a good return on undervalued stock. Growth stocks are riskier and don’t pay dividends regularly but you could make more in the long term. Sector funds concentrate on a specific industry whilst income funds are those that look for regular dividends on stocks.

A balanced fund is one that spreads the risk by using a variety of strategies. Index funds are those using an index like the S&P 500 to determine investments whilst actively managed funds are those using the fund manager to make such decisions. Bond funds can come in high risk, high potential, and low-risk, low potential forms. Money market funds are another low risk, but low return option. A fund of funds is a rather clever idea that involves investing in a variety of mutual funds themselves rather than in one specific one. It should be noted that hedge funds are not mutual funds.

There are a number of measures indicative of success. Firstly, the Net Asset Value (NAV) is the per-share current market value of the fund’s holdings and is updated every day. If the fund has multiple classes each will have its own NAV. Mutual funds (which are open-end funds) trade at the NAV unlike closed-end funds which can trade higher (a premium) or lower (a discount) than the NAV. A second measure is yearly turnover, which measures the securities transactions of the fund as a percentage of NAV.

Investors can incur costs in being in a mutual fund. The turnover of the fund leads to taxes for investors, for example. There are also fees to pay the expenses of the company. These include management fees, non-management expanses, and service fees to cover marketing expenses.

So these are the possibilities that you will need to explore further to enable you to successfully choose your mutual fund options. But the key thing will involve being very clear about what your goals are and then matching them successfully with the appropriate options.