Mutual Funds: Diversify Your Investing
- They are professionally managed and available at different investment minimums.
- You’re getting exposure to a larger portfolio and spreading the risk.
- Allow access to broad markets or focus on specific sectors or industries.
Diversification with mutual fundscall out
If you’re like most investors with a retirement plan, chances are you hold shares in mutual funds. In fact, today more than half of all 401(k) plan assets are held in mutual funds.1 Mutual funds offer the advantage of professional management along with the potential benefits of diversification.
With so many choices, how do you know where to start?
From the beginningcall out
As a mutual fund shareholder, you’re pooling your money with other investors to invest in securities such as stocks, bonds, cash and other investments. Having a diversified portfolio can help to spread out risk. Your shares represent part ownership of the fund, which in turn, gives you a “proportional right” to any income and capital gains generated from the investments.2
Mutual funds are popular because they offer an efficient way to diversify your investments without having to make a large initial outlay, and they’re generally cost-effective. Because a mutual fund manager researches, and selects the fund’s investments, and manages the fund’s allocation, rebalancing the portfolio when needed, and monitors the fund’s performance, you do not have to.
Redemption is also convenient. You can sell your shares at any time the market is open at the fund’s current net asset value (NAV).
Determine your objectives
The more clearly you define your investment objectives and your tolerance for risk, the better you’ll be able to determine which mutual funds are appropriate for you. As a mutual fund investor, you have goals for your investment. Start by choosing mutual funds that match your investment objectives, risk tolerance, and time horizon.
For example, let’s say your primary investment objective is generating income. You would look for funds providing ongoing, steady cash flow. On the other hand, if your objective is growth, you can invest in equity funds that have long-term growth of capital as the objective. If you’re not interested in seeing your account value fluctuate widely, then preservation of capital may be for you. Some mutual funds provide a combination of two or three of these objectives.
The more clearly you define your investment objectives and your tolerance for risk, the better you’ll be able to determine which mutual funds are appropriate for you.
Make your choicecall out
There are thousands of mutual funds from which to choose. How do you know which funds meet your investment objective and tolerance for risk? Start by looking into some key fund categories:
- Stock funds. Representing the largest mutual fund category, these funds invest in equities (e.g., large or small companies, domestic and international companies). Within this vast category of funds, you’ll find funds of varying investment objectives, sectors and geographic regions.
- Bond funds. Also referred to as “fixed-income” funds, these funds may invest in a wide range of debt securities which can include municipal, U.S. government, corporate or foreign debt.
- Money market funds. Often described as “cash alternatives,” these funds, by law, can invest only in certain high-quality, short-term investments with maturities of less than 13 months. Although they seek to maintain a stable NAV at $1 dollar per share and are considered less risky, it is possible to lose money investing in these funds.
- Balanced funds. Sometimes referred to as “hybrid funds,” these funds invest in a combination of stocks and bonds. They may offer income, capital appreciation, or both.
Each mutual fund states its investment objectives prominently in its prospectus.
The Financial Industry Regulatory Authority (FINRA) lists some of the individual funds within these categories within the Fund Analyzer (https://tools.finra.org/fund_analyzer/) available at www.finra.org. Whether growth, value, sector, target-date, etc., each fund has an investment objective and focus.
Assess your riskcall out
Before buying a mutual fund, there’s a lot to think over. You must consider all facets of the fund, including its investment objectives, the type of securities it owns, the strategies the fund uses to meet its objectives, the potential return, and any risks involved in owning the fund.
For details about the fund, including its investment objectives, risks, charges and expenses, refer to its prospectus.
Consider both advantages and disadvantagescall out
Mutual fund advantages include:
- Diversification. You own a small part in a large portfolio of investments. This lessens the chance a drop in any single fund holding will have a big impact on your fund’s account value.
- Professional management. You don’t have to be the expert if you don’t want to be. A professional portfolio manager is making the investment decisions for the fund.
- Redemption. You can generally enter an order to sell your fund’s shares at any time the market is open. Your shares will be redeemed at 4:00 p.m. Eastern Time or after the New York Stock Exchange closes on the day you entered the sell transaction.
- Minimum investment. You generally don’t need to have a large initial investment to own a particular fund. You can purchase a variety of funds for your portfolio.
But, mutual funds also have disadvantages, including but not limited to:
- Fluctuation. Mutual funds experience price fluctuations similar to those of the securities that make up the fund. Make sure you understand the level of volatility for the fund and your tolerance for market swings.
- No guarantees. Mutual funds cannot guarantee returns. Your shares, when sold, may be worth more or less that their original cost. Also, mutual funds are not guaranteed or insured by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Unlike a bank deposit, which is insured by the FDIC up to applicable limits, mutual funds have no such guarantee.
- Expenses. Mutual funds have annual operating costs, which include marketing, distribution and management and other fees. You may also pay transaction costs, which include commission fees and other sales charges.
- Lack of control. Because you don’t pick the investments in a mutual fund, you don’t have influence over which securities the fund manager buys and sells. You also can’t pick the timing or level of capital gains, if any, the fund will realize.
Mutual funds vs. ETFs
While mutual funds have been popular for decades, exchange traded funds (ETFs) are relatively new but have been gaining in popularity. As with mutual funds, ETFs are pools of investments. They may have lower expenses than mutual funds because of their passive structure (however, some mutual funds (index funds) are also passive in nature).
In addition, ETFs, like stocks, are traded throughout the day on a national stock exchange. Mutual funds are not traded and can be redeemed only once per day after the markets close, generally at 4 p.m. Eastern Time or after the New York Stock Exchange closes.
Below is a comparison chart highlighting some of the key similarities and differences between mutual funds and ETFs.
|Portfolio of investments||Yes||Yes|
|Pricing Frequency||End of day||Throughout the day|
|Active or passively managed||Generally active||Generally passive|
|Relatively low initial cost||Yes||Yes|
|Taxes||Generally less tax efficient||Generally tax efficient|
|Fee or commission to trade||Varies*||Varies*|
*except in fee-based accounts
Mutual fund key pointscall out
Mutual funds have been around for nearly a century. They are accessible at generally low minimums, provide access to professional management, and are a way to have part ownership of a professionally researched and managed portfolio (however, some mutual funds (index funds) are also passive in nature).
As with any investment choice, there are no guarantees your mutual fund will meet its objectives. All investing involves risk including the possible loss of principal. Mutual funds have risks, and their taxes and fees can lower any return.
Next stepscall out
- Mutual funds are popular because they offer diversification and are professionally managed.
- Mutual fund investing offers those with limited time a way to have part ownership of a professionally researched and managed portfolio.
- Like all investments, mutual funds have risks, and their taxes and fees can lower any return.
- Mutual funds are different from ETFs.
All investing involves some degree of risk, whether it is associated with market volatility, purchasing power or a specific security. There is no assurance any investment strategy will be successful or that a fund will meet its investment objectives. Stocks are more volatile than bonds and are subject to greater risks. Bonds are subject to interest rate, price and credit risks. Prices tend to be inversely affected by changes in interest rates. An investment in a mutual fund or exchange–traded fund (ETF) will fluctuate and shares, when sold, may be worth more or less than their original cost. ETFs are subject to risks similar to those of stocks and may yield investment results that, before expenses, generally correspond to the price and yield of a particular index. There is no assurance that the price and yield performance of the index can be fully matched.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.