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Mutual Funds

Mutual funds are the most common investment vehicle for individuals, because they don't require a lot of money to get started. They carry some other advantages, as well.

Show Me the Money

Mutual funds are investments that pool the money of many investors and place it in stocks, bonds, and other holdings. Unless the mutual fund is a particular type known as an “index fund,” the money is managed by a portfolio manager and a team of researchers. Index funds normally are not managed funds.

What are mutual funds? They're investments that pool the money of many people and place the cash into stocks, bonds, and other holdings. When you put your money into a mutual fund, you're throwing it into a pot with another couple hundred million dollars or so. Some mutual funds can go as high as a billion dollars or more.

The money is managed by a portfolio manager and a team of researchers, who are responsible for finding the best places in which to invest the money. While a portfolio is a group of investments assembled to meet an investment goal, a portfolio manager is someone who is paid to supervise the investment decisions of others. The managers get paid for their services from a fee within the fund, usually a percentage of the value of the fund. Although you don't see this fee, you should remember that it exists. The terms “portfolio manager” and “money manager” are used interchangeably. Both handle the management of a portfolio, be it for individuals or for a mutual fund. They are paid a percentage of the assets under management.

Money Pit

Be careful when you buy a no-load mutual fund. You won't pay any commission, but you could be charged fees for marketing and promotional costs (known as a 12(b)1 fee), fees for reinvesting your dividends, and other hidden fees. Make sure you know what fees will be charged before you agree to buy.

In addition to the portfolio manager's fee, there are several other fees you need to be aware of when deciding which mutual fund is right for you:

  • No-load mutual funds let you avoid paying a sales commission on your trans-actions. No-load funds are shown by advisers who receive compensation otherwise, often by an hourly rate. The companies that offer no-load funds have toll-free phone numbers that you can call for recommendations of what funds to buy.
  • Load funds pay sales commissions to a broker, financial adviser, insurance consultant, and so on. The load, or a portion of it, is paid to the adviser who recommends the mutual fund to you. If your mutual fund has a load, know how much it is and how you pay it. Fund loads/fees should be reviewed by the salesperson and stated in the prospectus (paperwork) sent from the company. Load funds have front-end loads, deferred sales charges, or back-end loads:
  • Front-end loads are fees paid up front. A 5.75 percent front load meansyou pay 5.75 percent of every dollar invested as a fee, and you invest the remaining funds. $100 invested means that $94.25 goes in the fund and $5.75 goes to the salesperson.
  • A deferred sales charge permits the load to be postponed, and it gradually declines over a period of years until the sales charge is 0. Thus, if you invest $1,000 in February in a mutual fund with a 5 percent deferred sales charge, you would pay 5 percent if you sell the fund the first year, 4 percent the second year, and so forth until the sixth year, when you could withdraw all the funds without a fee.
  • A back-end load means you pay a set fee upon the sale of the mutual fund. For example, if you purchase and then sell a fund within too short a time, certain funds will charge a back-end fee (often 1 to 2 percent).

Usually, how your financial adviser is paid determines the type of fund you're shown as a possible investment.

Mutual funds can offer you some great advantages:

  • Money can be taken directly from your bank account each month and transferred into a mutual fund. This makes investing nearly painless.
  • Mutual funds can offer diversification. If you are diversified, and one or more of your investments hits a slump, then you can rely on your other investments to boost your total portfolio. You could, for instance, divide your money among three or four different types of stock funds, ensuring that you'd always have some money invested in a profitable area of the market. Part of diversification is also investing in bonds, as well as just different types of stocks. It can be difficult for you to plan that diversification on your own, which is why people look to mutual funds to diversify their portfolios.
Show Me the Money

Diversification is investing your money in different se-curities in different industries, hoping to protect your investment against one or more companies undergoing financial disaster. Securities are investments that represent evidence of debt, ownership of a business, or the legal right to acquire or sell an ownership interest in a business.

  • It doesn't cost much out-of-pocket to buy mutual fund shares. If you purchase a no-load fund, you do not pay a sales charge to buy the fund. Brokerage for the investments within the mutual fund, or the cost of buying or selling shares of the stocks or bonds, are generally far lower than standard brokerage, because the fund managers buy or sell so many shares of a security at one time and buy and sell frequently. Having this power enables them to negotiate trades for a lot less money than you could on your own. Many people assume that mutual funds do not pay to trade securities, but that's a false assumption. Fees occur whenever a security is traded; although the fees are usually lower inside a fund, due to the large number of shares traded.
  • The Securities and Exchange Commission (SEC) oversees the records and expenses of all mutual funds.
  • You can direct almost any amount of money to where you want it. If you're into a mutual fund for the long haul, you can direct your money to funds that invest more heavily in stocks instead of directing your money to the more conservative bond funds.

If you're looking for mutual funds that don't require a lot of money to open or to be contributed to each month, consider the following options. They all were given high ratings by Morningstar Mutual Funds, a newsletter published twice a month by Morningstar, Inc. in Chicago:

  • American Funds: 1-800-421-0180 www.americanfunds.com
  • Fidelity Funds: 1-800-Fidelity www.fidelity.com
  • Oakmark Funds: 1-800-Oakmark www.oakmark.com
  • T. Rowe Price: 1-800-638-5660 www.troweprice.com
  • Vanguard: 1-877-662-7447 www.vanguard.com

One final advantage of mutual funds is that they carry almost no risk of going bankrupt. Due to diversification within a fund, a mutual fund is very unlikely to lose its entire value. You can invest $5,000 into XYZ Computer Company, and within 5 years, the value could drop to $0, but $5,000 invested a diversified general mutual fund should follow the ups and downs of the stock market, not just one stock.

Take a careful look at mutual funds as you begin to think about investing your money. They're a great place to start investing and are an excellent vehicle in which your money can grow.

More on: Family Finances

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Excerpted from The Complete Idiot's Guide to Personal Finance in your 20s and 30s © 2005 by Susan Shelly and Sarah Young Fisher. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

To order this book visit the Idiot's Guide web site or call 1-800-253-6476.


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