What you need to know about mutual funds

Discover 10 essential things you need to know about mutual funds. Types of funds and costs, benefits and risks, and how they differ from other products.

Jack Bogle is 89 years old. He is also one of the most important people in American finance. Yet, unlike other successful money managers like Warren Buffet, very few people would recognize him.

Jack founded Vanguard in 1975 and as of January 2018, the company had more than 20 million customers. At that time, its total assets under management were $5.1 trillion making it the second biggest money manager after Blackrock, which has more than $63 trillion.

The difference between Vanguard and other money managers is the approach to investing. The company specializes on mutual funds. Its core purpose is ‘to take a stand for all investors, to treat them fairly, and to give them the best chance for investment success.’ Unlike other managers, the company does not charge high administrative and incentive fees. As a result, the company has not produced billionaires. In fact, Jack Bogle is worth less than $100 million. This article will look at the mutual fund industry that Bogle pioneered and highlight its most important aspects.

What is a mutual fund?

As an investor, you can decide to go it alone and conduct your own in-depth research on securities that you might invest in. Alternatively, you can give your investment funds to a money manager who invests in securities they believe will do well. The challenge with this is that many managers tend to charge exorbitant fees. For example, hedge fund managers charge a 2% administrative fee and another 20% incentive fee. This means that if you have invested $2000 and the manager delivers a 10% return, the manager will pocket $80. Your profit, on the other hand, will be $120.

In a mutual fund, investors pool their money together and give it to a money manager. They direct the manager on the type of investments to make. For example, if it is a large cap bond fund, the manager will find opportunities in the large cap stocks. The profit of the mutual fund is then distributed to the fund holders. The manager receives a management fee.

What is an expense ratio?

The expense ratio of a mutual fund is very important. It is the cost mutual fund companies charge investors to manage the fund. It is calculated by dividing the operating expenses of the fund and the total dollar value of the fund. For example, if the fund has assets of $1 million and the expenses are $25,000, the expense ratio is 0.025. In most cases, the common expense ratio is usually between 0.5% and 1%. It rarely goes above 2.5%.

There are many factors that affect the expense ratio of a fund. For example, an international fund will have a higher ratio because of the extra costs associated with international travels. In addition, the total number of the people managing the fund determine the costs.

Other costs

Apart from the expense ratio, it is important for you to understand the other costs associated with mutual funds. The front load are the charges required when you invest in the fund. For example, if you want to invest $1,000 in a mutual fund that has a 5% front load, you will need to pay $50. The back load is charged when you sell the fund. It is also known as the deferred sales charge. There are other funds that have a ‘no load’ or ‘load waived’ policy.

Benefits of mutual funds

There are a number of benefits of investing in mutual funds:

Risks of mutual funds

As with all investment products, mutual funds come with their risks:

Past performance is not an indication of future performance

When making a decision on the mutual fund to invest in, you will likely consider the past performance. However, it is important to note that the past performance of a fund does not always mean that future performance will be good. To decide on the fund you want to invest in, you should look at the company offering the fund, the money manager and how long they have been with the fund. You should also look at their track record and career background.

How mutual funds make money

Mutual funds make money in a number of ways. Funds that invest in stocks make money when the stock price moves up. For example, if a stock of a company moves from $10 to $13, the value of the fund invested rises by 30%. They also make money from the dividends that are paid by the companies. Those that invest in REITs make money from the stock price and the annual distribution. Those that invest in bonds make money from the yields generated from the bond.

Type of mutual funds

There are different types of Mutual funds that depend on the assets that the fund invests in. They can be divided into stock funds, bond funds, hybrid funds and money market funds.

According to structure

Open for everyone

A common misconception about mutual funds is that they are not intended for young people. However, the earlier a person starts to invest in funds, the better it may perform for them. This is because, by the time they retire, their investment will be worth much more. Like with all investments, a good risk strategy for investing in mutual funds is to diversify your portfolio and returns with other securities such as stocks, bonds and even more high-risk/high-return vehicles like Forex.

Start investing in mutual funds today

In most mutual funds, you don’t need a lot of money to get started. It is possible to create a portfolio of different mutual funds with less than $5000. The key to success is to conduct your due diligence on the funds. Here, you should look at the historical performance of the fund, the manager of the fund and the constituents of the fund.

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