Basic Types and Categories of Mutual Funds
How Do I Buy a Mutual Fund? Mutual funds are primarily bought in dollar amounts unlike stocks, which are bought in shares. Mutual funds can be purchased directly from a mutual fund company, a bank, or a brokerage firm. Before you can start investing, you’ll need to have an account with one of these institutions prior to placing an order. A mutual fund will be either a “load” or “no-load” fund, which is financial lingo for either paying a commission or not paying a commission. If you are using an investment professional to assist you, you will likely need to pay a load.
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Mutual Funds Are Diversified Investments. The nature of mutual funds as pooled investments that are professionally managed means that investors generally can easily accomplish one of the most important standards of smart investing — diversification. To diversify means to spread market risk by holding a variety of several different securities, rather than just a few. Most mutual funds invest in dozens or hundreds of stocks or bonds within one portfolio. Depending upon the type of fund, this accomplishes the fundamentals of diversification with as little as one or two mutual funds. However, when building a portfolio of mutual funds, especially as investment assets and objectives grow more complex over time, investors are smart to diversify across several funds in different categories.
While it can be confusing, the answers to the following three questions will help you navigate the mutual fund waters—from how they work to how to add them to your investment portfolio. What Is a Mutual Fund? For all intents and purposes, mutual funds serve as an alternative for investors who can’t afford an individually managed account. Mutual funds are formed when investors with smaller amounts of capital, pool their money together and then hire a portfolio manager to run the consolidated pool’s portfolio—subsequently buying different stocks, bonds, or other securities in a manner consistent with the fund’s prospectus. Each investor then receives their respective piece of the pie while sharing the expenses, which show up in something called the mutual fund expense ratio.
Investors Can Buy Many Different Types of Mutual Funds. Investment objectives are unique to every investor, which means that there are many different reasons to buy mutual funds. Fortunately, there are several categories of funds that can suit any investment need. Some of the most common investment objectives include retirement and education, each of which may require different funds to suit the needs of the investor. Target retirement funds are good examples of low-cost, diversified funds tailored to meet a variety of time horizons. This category of funds will invest in other mutual funds that combine to be suitable for a certain age range of investor. Target retirement funds are categorized by decade. For example, a 25-year old investor may expect to retire in 35 to 45 years. Therefore a fund like Vanguard Target Retirement 2050 (VFIFX) can work well in a 401(k) or IRA for this investor.