Everything You Need to Know About Mutual Funds
We often hear about mutual funds during conversations about finances or retirement investing. And many of us work for organizations that invest our retirement monies in mutual funds. What are they?
We’re going to answer some of your questions around the benefits of mutual funds and the risks of mutual funds. We’ll look at how they work, how to start investing in mutual funds, and answer the question “Should I invest in mutual funds?”
But first, we need to start with, “What are mutual funds?”
What are Mutual Funds?
Over 400 years ago, Miguel de Cervantes, the author of Don Quixote, penned “[...] ‘is the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket.” Even then, people understood that investing all your resources in one thing was unwise. Diversifying was better because it provided a layer of protection if things went badly.
Today, mutual funds are a way to have a diversified portfolio and secure investments. A mutual fund is a company that pools money from investors to buy securities such as stocks, bonds, and short-term debt. These financial holdings are combined to become a portfolio, and investors buy shares in the mutual funds.
Each share you buy gives you part ownership in that mutual fund and the income you receive from that fund is based on the amount that you have invested. Mutual funds invest in a range of companies and industries and are overseen by experienced professionals who do the research and monitor the investments.
How Do Mutual Funds Work?
It makes sense that having a range of investments is a good idea to mitigate risk and provide financial security, but how do mutual funds work?
Mutual fund firms will often talk about investments in terms of models. These models are forward-looking spreadsheets created to help investors see the potential performance of their investments. In essence, they pull facts, figures, and projections to create a hypothetical portfolio. This information is very helpful as you weigh the benefits of mutual funds and the risks of mutual funds.
When you invest in mutual funds, you become a part-owner through your shares. The fund’s investments, like stocks and bonds, pay out income in dividends and profit. The mutual fund, in turn, will take those profits, minus fees, and then distribute them to investors through income distributions.
When your mutual fund has capital gains from selling a portfolio investment at a profit, you will receive what is called capital gains distribution. Your choice here is to either take the money in cash or you can reinvest it back into the fund.
There are three common types of mutual funds. Let’s take a brief look at each.
As the title suggests, stock funds look to primarily invest in stocks. Each stock is a unit of ownership in a company and the profit of ownership happens when the stock increases in value or when dividends on that stock are paid. While money can be lost in stocks, if a company fails, an investor isn’t liable for that company’s debts. Stock funds are a good long-term investment strategy.
Bond funds are investments in bond securities. When an entity like a company or government agency purchases a bond they make a promise to repay the loan on a certain date and to make scheduled interest payments until that loan maturation date. Bond funds lean towards being less volatile than stocks and they produce regular passive income.
This fund has an eye toward investing in short-term, interest-bearing securities. Money markets are short-term IOUs that federal, state, or local governments and U.S. corporations issue. Because they are defined as high-quality and mature quickly, money market investments are relatively stable.
Benefits of Mutuals Funds
There are several benefits of mutual funds. The one usually mentioned first is diversification. Investing in mutual funds lets you build a diverse portfolio without having to select individual stocks or bonds. Mutual funds also offer a range of asset classes and sectors.
Mutual funds are managed by skilled professionals research for you. Their wealth of knowledge and experience allows them to make wise decisions about selecting securities and they monitor the performance of the fund.
Mutual funds are convenient because they allow investors the opportunity to be paid in three ways.
1. Dividend Payments
New investors may wonder, “Do mutual funds pay dividends?” The answer is yes, they do. When a fund earns money from stock profits or interest on bonds, all that money, minus expenses is paid out to investors.2. Capital Gains Distributions
A capital gain is the money made from the sale of a security that increased in price. At the end of the fiscal year, the money from that capital gain is distributed to investors (less fees and expenses).3. Increase NAV
A NAV, or Net Asset Value, increases when the market value of a portfolio, minus fees and expenses, increases. The higher value of your investment is reflected by this higher NAV.
Risks of Mutual Funds
Risk is inherent in everything we do and that includes investing. While professionals manage mutual funds and diversification does provide security, investors must understand the benefits and risks while asking themselves, “Should I invest in mutual funds?” Some risks to consider are:
1. Inflation Risk
Purchasing power is impacted by inflation and increased inflation rates and higher costs of living can diminish that. This has a trickle-down effect because less purchasing power leads to a reduction in big-picture returns.2. Liquidity Risk
Unlike individual securities which are traded around the clock, the pricing and trading of mutual funds typically happen once a day - usually at the end of the day. Even if you enter a trade early, the price you receive is completely dependent on the NAV when that trade is executed.3. Interest Rate Risk
Bond prices, in particular, are affected by fluctuations in interest rates. If the interest rates increase, bond prices decline and that may impact the value of mutual funds that are heavy into bonds.4. Market Risk
Your mutual fund performs only as well as your investments and the performance of investments is based on the actions in the market. The market can be impacted by the economy, the political climate, terrorism, natural events, etc. The value of your investments will fluctuate depending on market events.
How to Start Investing in Mutual Funds
Now that we’ve answered “What are mutual funds?”, “How do mutual funds work?”, “Should I invest in mutual funds?” let's talk about how to start investing in mutual funds.
Before you begin, take some time to assess your financial resources and consider what your financial goals are. Know your income vs expenses, your debt burden, and your net worth. You will then understand how much you have to invest and avoid overextending yourself or taking unnecessary risks. Now that you know where you stand, let’s discuss a few more helpful steps.1. What types of mutual funds make sense for you?
What will your portfolio look like? Will it be stock funds, bond funds, money market funds, target-date funds (a combination of stocks and bonds that help you to retire by a certain date), or a combination?
2. Is your investment strategy active or passive?
Actively managed funds are overseen by a professional who monitors the performance of the fund. This is a great way to invest but keep in mind that fees and expenses will cut into profits.
Passive investing is a strategy with an eye on the long term. It minimizes buying and selling. This strategy invests in securities that will grow over the long term and it doesn’t have the fees and expenses associated with having an account managed by a fund professional.
3. Start Investing!
Mutual funds investing can be done a few ways - work retirement plan, IRA, or opening a brokerage account. When opening a brokerage account, understand the minimum amount requirement, total costs, the website or app’s ease of use, and the funds you have available.
Connect Invest Short Notes - Mutual Fund Model In Mind
Connect Invest short notes are an excellent way to diversify your investment portfolio. These investments fund a portfolio of real estate loans. Your investment is diversified across many real estate projects, making it a sound mutual fund model.
Short note investments generate passive income and the low minimum of $500 makes mutual fund investing accessible. It takes just a few moments to set up an account. From there you will fund your digital wallet and make an investment selection. You will earn monthly interest, paid in arrears one month after your initial investment until your note matures.
There is no time like the present to begin investing in mutual funds, and our team would be delighted to answer any questions you may have. You can also find answers in our FAQ section.
When you invest with Connect Invest, you have control over where your money is invested, and you begin earning a passive income right away. What are you waiting for?