What is a mutual fund?
A mutual fund is an investment that pools together multiple stocks, bonds, and other securities to perform as one investment. Mutual funds are typically named after the type of investment that they focus on.
How do they work?
Mutual funds combine money from many investors and place the money in stocks, bonds, securities, or a combination of the three. They are managed by a professional portfolio manager who actively adjusts the funds portfolio to either match an index or to maintain a specific risk profile. What is important is to understand the mutual funds plans for your money. Index funds can be very attractive to investors since the costs of managing an index fund are lower than other funds and this translates to more money in your pocket. For example, the Fidelity Spartan 500 (FUSEX) fund targets the performance of the S&P 500 as an index and has management fees as low as 0.10%. (Note: I am invested in this fund.)
Benefits of mutual funds.
Mutual funds offer investors the advantages of diversification and professional management. Mutual funds also can make it easy to target an entire sector or index of the market with one single purchase. Typically mutual fund investing will require less focus and time since if one knows the sector or index being targeted then one only needs to pay attention to the activity within that sector or index. A mutual fund also provides investment opportunities to the average investor that would not otherwise be available to small investors. These features are what make them perfect for the average investor.
Potential limitations of mutual funds?
By their very nature, mutual funds are diversified (lower risk), which means that they will not likely experience the large returns that owning stock in a single well performing company may provide, but also they can avoid significant losses due to unforeseen events that would more readily impact a single company.
Mutual Fund Negatives
Mutual funds typically restrict the frequency of transactions. They do this to keep costs low for the entire group of investors that they represent. High frequency trading drives up the costs for all members. Most mutual funds will penalize/suspend an investor for conducting a purchase order followed by a sell order in less than 30 days (for some it is per quarter). Each mutual fund has its own rules and an investor should be sure to understand them before investing. Furthermore, all transactions are processed at the end of a trading day. Therefore, it is not possible to take advantage of midday market spikes, and if a purchase order is issued before the end of the day and the market suddenly rises significantly this can result in purchases made at the peak of a trend. However, it is important to note that one should be thinking long term when investing in mutual funds (a minimum of 1 year, but typically 5 years or more) and should not be concerned with the day to day perturbations of the market.
Mutual Fund Negatives
Mutual funds typically restrict the frequency of transactions. They do this to keep costs low for the entire group of investors that they represent. High frequency trading drives up the costs for all members. Most mutual funds will penalize/suspend an investor for conducting a purchase order followed by a sell order in less than 30 days (for some it is per quarter). Each mutual fund has its own rules and an investor should be sure to understand them before investing. Furthermore, all transactions are processed at the end of a trading day. Therefore, it is not possible to take advantage of midday market spikes, and if a purchase order is issued before the end of the day and the market suddenly rises significantly this can result in purchases made at the peak of a trend. However, it is important to note that one should be thinking long term when investing in mutual funds (a minimum of 1 year, but typically 5 years or more) and should not be concerned with the day to day perturbations of the market.
Mutual Fund Basics
- When investing for retirement it is important to first determine how close you are to retirement and to determine a proper asset allocation based on your needs.
- Avoid investing in a mutual fund that charges annual fees greater than one percent. Index funds can provide the best returns over time simply because their fees are typically the lowest.
- Do not select too many mutual funds. This will only make it harder to track. Try to avoid more than one fund per asset class in your portfolio (diversification).
- Despite the fact that many experts say a buy and hold/hope strategy is the best . Never just buy and hope your investments will perform well. Investing is not playing the lottery. Pay attention to what the broader market is doing especially the sector or index that your mutual fund attempts to match. At least once per quarter, but no more than monthly, evaluate the performance of your investments and the allocation of your portfolio. Reallocate to adjust for risk and market conditions. If an investment has done unusually well, it is probably time to sell some it to take profits from the gain.
- Always employ a cost averaging strategy when transferring money between positions. Always make transfers incrementally 1% to 20% of available funds per a transaction. Avoid moving 100% of an asset all at once.
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| Borrowed From: www.thewisdomjournal.com |
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