On this week’s episode of I’ve definitely heard this term before but for the love of God don’t ask me what it is, we’re here to help you understand mutual funds and navigate their pros and cons.
But let’s start with a quick definition for mutual funds.
Ever know someone who bought a timeshare vacation-home? Well a mutual fund is kind of like a timeshare of 100 (or 500 or 2,000) different properties that you, and everyone else who buys into them partially owns. Except instead of vacation homes, its an aggregation of many different investments (like a collection of stocks from 100 different tech companies).
One of the main benefits of a mutual fund is that it is managed by professionals. This means someone else is in charge of all the day-to-day work of stock-picking and dividend-reinvesting (taking the cash received from [mutual funds] dividends and using it to buy more stocks or bonds in the fund).
Having a manager also means someone else is in charge of diversifying your portfolio (purchasing many different stocks and bonds to minimize the risk of you losing lots of dough if some of the companies take a dive). It basically takes the power away from the performance of individual companies.
Diversifying your portfolio requires plenty of calculations and research, and you may feel more comfortable leaving this up to a human who has been educated and trained to professionally manage money. (Looking at you, finger-counter.)
Another big benefit of mutual funds is that it operates with economies of scale.
What the hell does that mean, Nav.it?
Well, if you have $1,000 that you’d like to invest in individual companies, you’re going to be limited with how many companies’ stocks you can buy. However, if you put that same $1,000 into a mutual fund, you now have small investments in hundreds or even thousands of companies And since mutual funds tend to be large, they can buy stocks in much larger quantities and pay lower overall transaction fees, which is another way of saying, more money for you.
The biggest complaint about mutual funds is their fees. Creating, advertising and running a fund is expensive. Some mutual fund companies have higher fees than others. Anything above 1.2 percent is an expense fee considered on the higher cost end.
Don’t forget your least favorite uncle…Sam.
If you invest in a mutual fund you are required to…drum roll please… pay taxes on your investment income. And what’s even more annoying is you can end up paying taxes on a mutual fund even if you’re losing money, because the mutual fund itself has to pay taxes — which is often passed onto the investors of the fund, which in this case is you.
However, taxes can be mitigated by holding your mutual fund in a non-tax sensitive retirement account like a 401k or a Roth IRA, so that’s something to think about.
And although you can request your money at any point, you will have to wait until the end of the trading day to get your cash from a mutual fund. (Unfortunately you cannot withdraw from a mutual fund like you can from your bank’s ATM.)
How to Invest
If you choose to invest in mutual funds, you can buy them from a financial planner or broker, or from a fund provider like Vanguard or Fidelity. There are also generally a few mutual funds available in the investment options of your 401k, so research your company’s options and see what strikes your fancy. Never forget…#knowledgeismoney.
Here’s what you need to remember if you couldn’t get through this lesson.When it comes to picking stocks, many people feel more comfortable spreading their wealth (AKA diversifying their portfolio, AKA not just investing in one or two companies), and like the idea of pros managing their investments. Enter mutual funds, the investment-version of that cliquey 8th grade group of girls who only ever do things together (if you want to spend time with Jessie, everyone knows Pam and Brittany M. are coming, too). However, when the inseparable girls turn out to be shares of Google, Apple, Amazon and 200 other companies bundled together, they may actually deserve your attention.
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