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.
Mutual Funds Are Accessible. Many mutual fund companies allow investors to get started in a mutual fund with as little as $1,000. Schwab’s mutual fund family has a minimum of $100 for many of their mutual funds. And since mutual funds can be easily traded, the combination of low cost and ease of use makes them accessible. Systematic Investing and Withdrawals with Mutual Funds. It’s simple to take advantage of systematic investing with mutual funds. Many mutual fund companies allow investors to invest as little as $50 per month directly into a mutual fund. Money can be pulled directly from a bank account and invested directly in the mutual fund. On the other hand, money can be regularly withdrawn from a mutual fund and be deposited into a bank account. There are generally no fees for this service.
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Saving for Your Initial Mutual Fund Purchase. Most mutual funds have what’s called a minimum initial purchase, which is the amount you’ll need to have saved prior to buying shares of your first fund. Most mutual fund companies have minimum initial purchase amounts of at least $1,000. For example, most of Vanguard’s mutual funds have a minimum initial purchase requirement of $3,000. Fidelity funds are typically at $2,500. However, once you make your first purchase, subsequent purchases of the same fund are usually as low as $100.
In addition, retirement plans (IRAs, 401ks, etc.) are not impacted by capital gains distributions. There are also strategies to avoid the capital gains distributions including tax-loss harvesting and selling a mutual fund prior to the distribution. Are There Disadvantages of Mutual Funds? Are there disadvantages of mutual funds? Absolutely, there are disadvantages of mutual funds. There are advantages and disadvantages of investing in each and every investment vehicle. However, if you come across a list of the disadvantages of mutual funds, scrutinize each item on the list and determine if it applies as a disadvantage of mutual funds or a disadvantage of a particular mutual fund (or to investment vehicles as a whole regardless of the structure).
Mutual Fund Fees Cover Administrative Costs. Mutual funds can offer streamlined investing but they’re not free. There are certain fees you have to be aware of when investing in mutual funds.