When it comes to building wealth through investments, mutual funds are a popular option. No matter what stage of life you’re in—from securing your first job to early retirement—mutual funds may be the right option to help you grow your wealth.
Read on to find out what mutual funds are, how they work, and other important information about mutual funds for potential investors.
What are Mutual Funds?
In the most basic sense, a mutual fund is a contribution of money from a number of individual investors, businesses, and other organizations. A fund manager is tasked with investing these funds and takes a fee—usually between 0.2% and 1% of the assets and sometimes other expenses. In exchange for this fee, you get the manager’s professional expertise and direction. The manager invests according to the type of fund. Fixed-income funds, for instance, have the goal of producing the highest returns with the lowest risk.
The Advantages of Mutual Funds: Diversification, Growth & Income
Mutual funds are popular because they give regular people the benefit of “bulk” or “mutual” investing. With money pooled from several sources, it’s easier to diversify an investment portfolio with stocks, bonds, and other types of securities. Investors can choose mutual funds that suit their needs, as well. Mutual funds can serve as a temporary savings account, or they can provide long-term returns based on the performance of global stocks. The convenience and flexibility of mutual funds has made them a popular option for individuals who want to build their wealth, especially those saving for a child’s education or retirement. Others choose to use mutual funds as a steady source of long-term income.
What to Look For
There are different types of mutual funds. Make sure you understand the following characteristics of mutual funds in order to choose the option that best meets your needs:
- Load vs. No-Load. Load funds take a cut of any additional money given to the fund, or a cut of the money withdrawn from the fund. No-load funds do not have any sales charges.
- Open- vs. Closed-End Funds. Open-end funds sell shares to anyone with the money to purchase them. The price of a share in the fund is determined by the value of the fund’s investments—this price is calculated daily following the close of the U.S. markets. Closed-end funds allot a limited number of shares. These shares are then traded like stocks on the stock exchange. The price of closed-end funds can fluctuate both above and below the actual value of the underlying investments.
High-Yield vs. High-Risk
Choosing investments is always about balancing the yield or profits made from the investment and the risks. High-yield investments tend to be associated with higher risks. Generally speaking, the higher the potential for profit, the higher the risk of a loss. All funds have some level of risk, though diversification can serve to minimize risks. It’s up to you to understand how risky a mutual fund is before you invest, and to understand how that risk is balanced with the potential for return. Some investors choose low-risk investments that provide modest returns over high-risk, high-yield investments.