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For most investors, mutual funds are a great way to build a diversified portfolio without a lot of extra cost or hassle. They typically own hundreds if not thousands of different stocks, bonds and other securities, providing you with instant diversification. Follow these seven simple steps to get started investing in mutual funds.
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1. Decide on Your Mutual Fund Investment Goals
What financial goals would you like to reach by investing in mutual funds? Are your goals only a few years away or decades in the future?
If you’re investing for a long-term goal, like retirement or your child’s college education, stock mutual funds are a great choice. You’ve got plenty of time to ride out the inevitable ups and downs of the stock market. While no investment guarantees a return, mutual funds are safer than some other options because you’re invested in a broad range of companies or debts.
If you’re saving for a shorter-term goal, like buying a home or a car within the next few years, a bond market mutual fund might be a better option. Investors who need easy access to their money in the very short term should consider high-yield savings accounts, which provide greater liquidity and are federally insured up to at least $250,000.
2. Pick the Right Mutual Fund Strategy
Once you’ve identified your mutual fund investing goals, you can pick funds with the right investment strategy tailored to your goals.
- Long-term goals. Long-term mutual fund investing means you have decades to reach your financial goals. With that in mind, your mutual fund allocation should probably be 70% to 100% in stock-based mutual funds to position yourself for the most investment growth. You may look specifically for mutual funds labeled “growth funds” to invest in companies that are expected to grow faster than others. These funds have more risk, but they also have more potential for large gains. Growth mutual funds to consider include the Vanguard Growth Index Fund (VIGAX) and Fidelity Growth Discovery Fund (FDSVX).
- Mid-term goals. If investing heavily in stocks makes you nervous or you have a goal that’s within five to 10 years away, you may want an approach that reduces the potential for rapid changes in investment value. Balanced mutual funds invest in both bonds and stocks, offsetting some of the risk associated with stocks. Balanced mutual funds to consider include the Vanguard Wellesley Income Fund (VWINX) and the American Funds American Balanced Fund (ABALX).
- Near-term goals. If you are only a few years away from your goal, your focus should be on minimizing risk so you don’t wind up short money when you need it. You might aim to invest 30% in stock mutual funds and the rest in bond funds. The bond funds will produce a steady income through interest payments while the limited stock component may allow you to see some investment growth. Income-oriented mutual funds to consider include the PIMCO Total Return (PTTAX) and the Vanguard Equity Income Fund (VEIPX).
If you’d prefer to avoid the hassle of picking a portfolio allocation, consider investing in a target-date fund. Target-date funds target a specific year in the future when the investor needs to withdraw their funds and provide a complete, well-diversified allocation of equity and bond holdings. The further from that date, the more the fund invests in riskier assets like stocks. As the target date approaches, the fund gradually adjusts its holdings to lower-risk assets like Treasury bonds.
3. Research Potential Mutual Funds
When researching potential mutual funds to invest in, use tools like the Mutual Fund Observer and Maxfunds. These sites provide detailed information on different mutual funds in multiple categories. Most brokerages’ websites also include mutual fund research tools and screeners for clients.
Consider the following factors to help you refine your list of mutual fund choices:
- Past Performance. While a fund’s past performance is no guarantee of its future success, how a fund has historically performed can be a good indication of how well the fund is meeting its stated goals. Compare past performance to similar mutual funds or benchmark indices.
- Expense Ratios. These are annual fees that compensate the fund’s managers and cover the cost of buying the fund’s investments. The industry average expense ratio is 0.57%, but you can find many funds that charge much less. While most expense ratios are less than 1% or 2%, it’s important to pay attention to these as they can drastically impact your money’s growth over time.
- Load fees. These are sales commissions charged by the broker who sells you a mutual fund. Mutual funds are often classified as “load” or “no-load” funds. Load funds charge commissions while no-load funds do not. You should try to avoid paying load fees, if possible. Given the wide range of funds available, you should be able to find comparable investments without fees.
- Management. Actively managed mutual funds aim to beat the performance of an underlying index. They usually charge higher fees and offer the potential for richer returns. Passively managed mutual funds—or index funds—aim to duplicate the performance of an underlying index.
They typically charge lower fees than actively managed funds. Historically, passively managed index funds have outperformed actively managed funds over the long term.
4. Open an Investment Account
If you participate in an employer-sponsored retirement plan at work, such as a 401(k) or 403(b), you already have access to mutual funds. Most retirement plans direct your contributions to mutual funds rather than individual stocks or bonds, and you can typically elect to invest in target-date funds if you’d prefer to automate your portfolio management.
If you don’t have access to an employer-sponsored retirement account or are investing for a goal outside of retirement, you can invest in mutual funds by opening a brokerage account on your own and investing in the following plans:
- Individual retirement accounts (IRAs). You can invest in mutual funds for retirement via tax-advantaged IRAs.
- Taxable brokerage accounts. Taxable accounts at an online broker lack the tax benefits of 401(k) plans or IRAs, but you can make withdrawals at any time without paying penalties. This makes them particularly well suited for goals you’d like to achieve before 59 ½, the federal retirement age.
- Education savings accounts. If you have children and want to save for their college education, you can open a 529 college savings account and invest in mutual funds.
5. Purchase Shares of Mutual Funds
To start investing in mutual funds, make sure you have enough money deposited in your investment account. Keep in mind that mutual funds may have higher investment minimums than other asset classes. For example, Vanguard’s minimum investment for actively managed mutual funds is $3,000. Other investments, like individual stocks or ETFs, generally do not have these kinds of minimums.
You can also buy ETFs and stocks at any time during the trading day. Mutual funds, on the other hand, only trade once per day after the market closes. This distinction may not be important for those who are investing for longer-term goals and who aren’t trying to make a quick buck through market swings.
While it might seem mutual funds trail stocks and ETFs, they do edge those other investments out in one key way: it’s generally easier to purchase fractional shares of mutual funds. This means you can invest any dollar amount instead of being limited to investing only in intervals equal to whole share prices. This lets you get more of your money invested and growing in the market sooner.
That said, while historically, you haven’t been able to do fractional investing with ETFs or stocks, increasingly more brokerages and micro-investing platforms are enabling clients to buy partial shares of ETFs and certain stocks.
6. Set Up a Plan to Keep Investing Regularly
Investing isn’t a one-off event for most people, and if you plan to grow wealth or reach money goals, you’ll want to establish a plan to keep investing. Your brokerage trading platform can help you set up recurring investments on a daily, weekly or monthly basis so you don’t have to remember to deposit money into your account every time you want to invest.
Not only does this help you grow money, but it also may help you pay less per share thanks to an investing principle called dollar-cost averaging. By investing a set dollar amount regularly, you reduce the risk that you buy a lot of mutual fund shares when prices are extremely high. And on the flip side, because you’re investing a set amount of dollars, your money buys more shares when prices are low. Over time, this may reduce the average price you pay per share.
You’ll also want to set up a plan to check in on your investments at least once a year. This will give you a chance to rebalance your portfolio and make sure that its asset classes still match the level of risk you want to take on to meet your goals. Portfolio rebalancing is important, so if this prospect sounds daunting to you, you might look into robo-advisors, which are automated platforms that generally offer this service as part of their management services.
7. Consider Your Exit Strategy
Eventually, you’ll want to sell your mutual fund shares to pay for your financial goals, such as making withdrawals during retirement.
If you bought mutual funds with backend loads, you’ll have to pay a fee to your broker when you cash out. You’ll also probably owe taxes on any capital gains your investments made unless you held them in a Roth IRA or Roth 401(k). Consider speaking with a financial advisor or tax professional to determine strategies to minimize the taxes you may owe on your investments.
Mutual Fund FAQs
What Are Mutual Funds?
Mutual funds are investment vehicles that allow groups of investors to combine their financial resources to purchase large portfolios of stocks, bonds and other securities. They’re a good investment option for the average investor since a single share of a mutual fund gives you exposure to hundreds of stocks or bonds. This diversifies your investment dollars and reduces the risk that any one company will cause your investment to lose value.
How Do Mutual Funds Work?
Mutual funds invest in baskets of securities, like stocks and bonds. A fund manager decides what to include in the mutual fund and when to buy and sell holdings. For people who don’t have the time, education, money or willingness to manage a large portfolio of investments, mutual funds are an excellent option.
Are Mutual Funds a Good Investment?
For many people, mutual funds are a better investment choice than individual stocks and bonds for the following reasons:
- Professional management. The fund manager does all of the research and monitors the performance of the securities for you.
- Diversification. By investing in a mutual fund, you invest in a range of securities rather than just one or two.
- Low Costs. Mutual funds are relatively affordable and let you purchase hundreds of securities for a fairly low cost.
What’s the Difference Between a Mutual Fund and an ETF?
Mutual funds and exchange-traded funds (ETFs) both involve investing in baskets of securities and are generally less risky than investing in individual stocks or bonds. However, there are a few key differences:
- Trading Options. You can buy and sell ETFs throughout the day with real-time pricing. By contrast, mutual funds can only be bought or sold at the end of the day after the market closes. Again, for long-term investors this distinction may not be significant as you aren’t generally trying to time the market for particular prices.
- Lower costs. ETFs never charge load commissions, and trading ETFs is free of commissions at most brokerages. This is not always the case with mutual funds, so make sure you understand any applicable fees your brokerage may charge before buying mutual funds there. ETFs are nearly always passive investments, like index funds, and charge much lower expense ratios than actively managed mutual funds. Some mutual funds, however, are index funds like ETFs and charge comparable expense ratios.
Which Mutual Funds Should I Buy?
Identifying the best mutual funds is dependent on your financial goals and risk tolerance. However, one of the most popular mutual fund strategies is to take advantage of index funds. Index funds are mutual funds that track the performance of a certain stock market index, such as the Dow Jones Industrial Average, the NASDAQ Composite Index or the . With index funds, you don’t have to worry about picking winning stocks yourself. And while index funds’ performance will never exceed the overall market’s, historically, they do generally outperform actively managed mutual funds that charge higher fees.
