What is a mutual fund?

A mutual fund is an investment company which collects money from a variety of individuals and invests the funds in stocks, bonds and other securities. A professional manages the purchase and sale of securities in the fund using indexes or his or her financial expertise. Investors own a small share of each of the mutual fund company’s securities. Investors can purchase shares from the fund itself or through banks and other financial planning professionals.

In general, when investors purchase shares, they pay the current net asset value, or the value of one share in a fund, plus sales charges. It’s important to remember the return and principal values of mutual funds fluctuate, and they are not guaranteed or insured by banks or government agencies. A prospectus is available from each mutual fund company, which can provide you with important information, such as risks, fees, expenses, and investment objectives.

Types of mutual funds

There are many different mutual fund companies and many ways to categorize mutual funds. Major categories include:

  • Funds by investment objective
  • Funds by asset class
  • Funds by redemption policy
  • Funds by management style or investment strategy
  • Funds by level of diversification
  • Funds by investment philosophy

Each fund has different risks and rewards, and it’s important to assess your own financial goals before selecting to the proper mutual funds to invest in. Compare mutual fund companies to others of the same type and funds in your portfolio. Ideally, you should strive for diversification to avoid having too many funds with the same goal or invested the same securities. The appropriate mutual funds will help you pursue these goals. Don’t hesitate to seek expert help if you find yourself overwhelmed or want to learn more about how to invest in mutual funds.

Earning money with mutual funds

Investors earn money from mutual funds in a variety of ways when the stocks, bonds, or other securities held by the fund increase in value or pay dividends or interest. For example, a fund can earn money by selling a security which has increased in price, in which case the fund has capital gains that are distributed to investors (minus any capital losses). If a fund decides not to sell but rather holds onto securities that have increased in price, but you then sell your shares in the fund, you could make a profit when you sell due to the fund’s increase in net asset value. A fund can also capitalize on dividends or interest on its securities, distributing the income among fund’s shareholders. Investors can accept payment of distributions or dividends or reinvest, often without paying additional sales loads.

Advantages of mutual funds

  • Investment risk is spread out over many stocks and bonds
  • Cost of securities are lower due to bulk purchases and sales
  • There can be a relatively low initial investment
  • Actively-managed funds benefit from investment professionals’ skills
  • Open-end mutual funds are relatively liquid and shares can be redeemed at any time

Tradeoffs with mutual funds

  • Funds with high expenses can impact your net return
  • To meet investor redemption requests, a fund can keep part of its assets in low-paying cash alternatives which reduces returns to investors
  • A fund manager may have poor judgement
  • Your investment can be affected by other investors’ actions
  • Most mutual funds involve added annual expenses
  • Some funds impose redemption fees if investors redeem shares before a certain amount of time

Costs associated with mutual funds

Common costs include sales loads and transaction fees for purchasing, selling, or exchanging your shares. They also can have ongoing expenses, such as 12b-1 fees and management fees.

Impact of taxes on mutual funds

Taxes can have a significant impact on your net return. It’s important to gather as much information as you can before investing in a fund. Look into if a fund is designed to minimize shareholders’ tax liabilities, how the timing of purchases and sales affect your tax liability, whether to hold a fund in a taxable or tax-advantaged account, and how to calculate the cost basis of shares when planning to sell.

If you’re interested in learning more about how mutual funds can be part of your investment portfolio, give us a call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investors should consider the investment objectives, risk, charges and expenses of the mutual fund carefully before investing. The prospectuses and, if available, the summary prospectuses contain this and other important information about the mutual fud. You can obtain prospectuses and summary prospectuses from your financial representative. Read carefully before investing.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The payment of dividends is not guaranteed. Companies may reduce or eliminate payment of dividends at any given time.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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