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Demystifying Mutual Funds

Mutual funds are an essential part of your personal finances. They are the fuel of your retirement plan, can help you buy a house and the easiest way to take advantage of the stock market. If you don’t have any money saved, you can still start investing in mutual funds immediately. With over 12,000 mutual funds in the marketplace, they can definitely be overwhelming! 

A mutual fund is a group of stocks or bonds (and sometimes both). When you buy shares in a mutual fund, you are buying equity in all of its holdings.  The rule of thumb is that if you have less than $75,000 to invest, you should stick to mutual funds to be properly diversified. For a small management fee (more on this later), you get a qualified money manager to manage your money. Mutual funds are much easier than individual stocks and bonds to monitor and determine how your investments are performing. Plus, if you don’t have a lot of money, you can start investing in mutual funds for as little as $50 per month!   

Because there are so many mutual funds out there, it can be overwhelming on where to begin and how to select a mutual fund that is right for you. The first place to start is to determine what your needs are. Do you want the investment for the short-term (less than 3 years) or mid-term (5-7 years) or long-term (10 years or longer) – like retirement? This will help you decide what kinds of mutual funds you should buy. You want to make sure you are properly diversified which means you are spreading your risk among different types of mutual funds.  

If you are investing for the short-term, you should stick with relatively safer Money-Market Funds. For the Mid-Term and Long-Term, you want to build a portfolio with a combination of Large-Cap Growth, Large-Cap Value, Small or Mid-Cap, International and Bonds. The percentage you want in each of these categories depends on your age, time horizon and risk level. If you don’t have any investments and only a small amount to invest, a great mutual fund to choose is a Balanced Fund (also called a Domestic Hybrid or Moderate Allocation). This is one mutual fund that combines stocks and bonds. There is also the Target or Lifestyle Mutual Funds. You pick the mutual fund according to the date that you want to retire (ex: 2030) and it will combine all the investments you need for a diversified portfolio. I call it One-Stop Shopping. 

You have three main choices from where to buy a mutual fund. You can go to a mutual fund company, such as Vanguard or T. Rowe Price and pick five mutual fund styles such as: Large-Cap Growth, Large-Cap Value, Small or Mid-Cap, International and Bonds. Or, you can go to a mutual fund supermarket such as Fidelity or Schwab. There is a lot to pick from here, which can also be overwhelming. Lastly, you can go through a broker. The broker usually suggests which mutual fund to buy. Just be careful because this is the most expensive route and the broker might be “pushing” a certain fund based on the commission he or she gets paid.  

If you don’t have the minimum needed for a mutual fund (which is usually $2,500), some of these mutual fund companies will let you invest $50 a month as long as you make it automatic and link it to your checking account. For a list of mutual funds that offer low minimums, visit Mutual Fund Education Alliance.

 

(Copyright Down-to-Earth Finance LLC 2006)

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