If you’re just venturing into the world of investments, then mutual funds are a great place to start. A favorite of practiced experts and beginners alike, mutual fund investments have gained a lot of attention over the past decade as a practical way to save for retirement, build a financial portfolio, and achieve other financial goals. As with any investment, it’s worthwhile to take a look at the information available in order to make the most educated decision. So, let’s take a look at how mutual funds work and what to consider before investing.
How Mutual Fund Investments Work
According to the United States Securities and Exchange Commission, a mutual fund is defined as “a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments.” Essentially, each share represents the investor’s proportionate ownership of the fund’s holdings and the income those holdings generate. The factors that distinguish mutual fund investments from other financial vehicles include the following:
- Investors purchase shares from the fund itself instead of from other investors.
- The price investors pay for mutual fund shares is the fund’s per share net asset value (NAV) plus shareholder fees.
- Mutual fund shares can be sold back to the fund, and new shares can be created to accommodate new investors.
You might have heard the term “hedge fund” before. There is a misconception that hedge funds are synonymous with mutual funds, but these terms actually refer to two very different things. Hedge funds are private, unregistered investment pools that do not follow the same regulations that apply to mutual fund investments for the investor’s protection – regulations that require liquidity, redeemable shares, and fairness in pricing.
Things to Consider
One of the reasons mutual fund investments are popular is because they are relatively inexpensive to invest in. Their affordability factor makes them very reasonable for the common or beginning investor to pursue because you can invest virtually any amount of money in mutual funds, per the issuing company’s guidelines. They also offer diversification of funds, allowing your investments to be spread across a wide range of companies and sectors that lower your total risk.
However, there are some disadvantages to consider, too. There are costs associated with mutual funds despite any negative returns, including sale charges, annual fees, and taxes. Mutual fund investments also force the investor to give up a certain amount of control because investors generally cannot determine what a fund’s portfolio looks like at any given time. Furthermore, real-time pricing information is difficult to obtain because the price at which you purchase or redeem mutual fund shares depends on the fund’s NAV, which might not calculate until hours after you’ve placed your order.
All funds carry some level of risk. At the end of the day, the advantages of mutual fund investments far outweigh the disadvantages for many investors because they provide a practical way to delve into the financial world. It is important that you do your research before you invest, but mutual funds are a great place to start to reach your financial goals.
Information gathered from: http://www.sec.gov/investor/pubs/beginmutual.htm