Investing 101: Understanding Mutual Funds

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    Far too many Americans are sitting on the sideline when it comes to the stock market. Some fear losing their hard-earned money while others do not know how to invest.

    In fact, roughly 44% of people in the United States do not own any stock. These alarming statistics include ownership of individual stocks, retirement savings accounts, and mutual funds.

    With your money on the sidelines, you are missing out on the opportunity for wealth growth. If fear of loss is driving your decision, it is time to learn about mutual funds.

    Read on to learn how mutual funds should be part of your wealth management strategy. Explore topics such as how to invest in mutual funds.

    What Are Mutual Funds?

    Before we dive into how to invest in a mutual fund, it is important to define it. Unlike individual stocks, a mutual fund is managed by a professional group of money managers. They are financial experts and know which investment types produce the desired return.

    The mutual fund pools together money collected from a wide variety of different people, businesses, and groups. The collective group has the same desired return on investment (ROI).

    A mutual fund is made up of many different types of securities. Of course, a mutual fund includes common shares from well-known companies listed on the Dow Jones or S&P indices. It also includes other securities such as bonds and money market funds.

    Each investor is willing to accept a different level of risk. The investment manager takes this into account when developing the fund. Diversification is a part of the money manager’s strategy regardless of the investor’s desired return. Each mutual fund consists of hundreds of different securities.

    The intent here is that if one security fails it will not crash the entire fund. Instead, it only results in a nominal loss that is offset by gains on other securities.

    What Is a Mutual Fund Comprised Of?

    The composition of the mutual fund depends on what the investor base is looking for. Some investors that are closer to retirement are looking for low-risk growth opportunities.

    These types of investors do not want to put all of their money into high-risk investments like the stock market. Instead, their fund is going to include a greater share of low-risk investments like money market funds.

    Other mutual fund owners want a more aggressive investment strategy. Perhaps they are younger and understand that the stock market always bounces back after major corrections.

    A mutual fund designed for this group will include a greater share of stocks. Bonds, money market funds, and other assets will still be included. However, lower-risk investments are going to account for a small percentage of the total fund composition.

    The composition does change over time. Money managers are constantly looking for ways to increase the ROI.

    In a target-date mutual fund, the mix changes over time. For example, consider an investment with a retirement goal of 2050. With each passing year, the fund’s composition is going to gradually shift. As the fund approaches the target date, it will become increasingly more conservative.

    What Is the Difference Between a Mutual Fund and Other Investment Funds?

    Many people do not realize how a mutual fund differs from other types of investment funds. A perfect example of this confusion lies with exchange-traded funds (ETFs). In fact, 17% of existing investors cannot differentiate between the two funds.

    ETFs follow an index that is publicly traded on the stock market. Private investors can purchase ETF shares like they do any individual stock. ETF investors may react immediately to good or bad business news that affects their index.

    On the other hand, a mutual fund has rules that restrict its trading. You can only buy or sell mutual fund one time per day. This transaction has to take place after the market closes for the day.

    The reason for this is that a mutual fund is designed for long-term investments. These rules are intended to avoid the speculative nature of ETFs and individual stocks.

    Lastly, mutual funds are actively managed by a group of financial experts. While this is possible with an ETF, the vast majority of them are passively managed. In most cases, the benefit of having a money manager create your wealth for you is lost.

    How Does a Mutual Fund Work?

    Mutual funds are similar to individual stocks in some ways. For instance, you are purchasing a small ownership stake in a public company when you acquire shares.

    This is similar to how a mutual fund works. A mutual fund is also a company that is in the business of creating wealth.

    They pool their investors’ money together to generate additional wealth growth. When you buy shares of a mutual fund, you are also acquiring an ownership stake in this company.

    You may be wondering what happens when the stocks that a mutual fund owns issue a dividend. This money is paid out to investors in the form of a distribution. Investors can pocket the dividend proceeds or choose to purchase more shares of the mutual fund.

    In some cases, the mutual fund generates capital gains. The money managers are actively trading stocks during your ownership. When shares of a stock are sold for a higher price, capital gains are realized.

    The byproduct is similar to a dividend for mutual fund owners. The capital gains are passed to shareholders. Like dividends, shareholders either reinvest the capital gains to purchase more shares or liquidate the earnings.

    The prices of securities go up over time and this results in higher share prices for the mutual fund. You realize a profit when you decide to sell your shares.

    Understanding the Basics About Mutual Funds

    Now, you have a beginner’s level understanding of what a mutual fund is and how it works. It is not easy to make a positive ROI on the stock market.

    An experienced money manager making wise moves on your behalf is the best strategy. Your investment manager will help you identify the best mutual funds for 2021 so you can experience wealth growth.

    If you are interested in investing in mutual funds, contact Bogart wealth today to speak with an expert.

    Work with a financial advisor who puts your needs first.

    Want to talk first? Call us at
    (866) 237-0121

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