Tips For Starting Out In Mutual Funds

Jan 31, 2012

By Staff writer State Farm™ Employee

A mutual fund is an investment that pools together funds from many investors who have the same investment objectives. The money is managed by a professional who analyzes the financial markets and selects investments. And the pool is large enough to afford a diverse array of securities, something that can be too expensive for most individual investors to do themselves.

A mutual fund provides an opportunity to invest in a diversified portfolio. The access to professional management and a diversified portfolio makes mutual funds popular with many individuals who are investing for retirement, a child's college education, or other long-term goals. Whether you are doing the research yourself or working with a registered agent, understanding some of the basics may help you make a more educated decision.

Starting Your Research

There are thousands of funds available, but how do you choose? Funds are broken down into a few basic categories: stock, bond, and hybrid (mixed stock and bond) funds,: lower risk and higher risk,: domestic and international. If you start by thinking about those categories and how they fit your goals, you can sort through the options a bit more efficiently.

The key offering information for a mutual fund is found in the prospectus, a document that explains the investment objective, the fees, and the fund management. Start with the investment objective. Does it fit what you are looking for? If you won't need this money for years, perhaps you may look to take more risk.

Fees And Expenses

The next thing to consider is the sales charge. Many funds charge investors when they purchase shares in the fund. This is known as a front load. Some will charge you a back end load when you take money out. This is used to compensate the registered agent who assisted you with your selection. Such assistance is valuable!

You should also take a look at the fund's expense ratio. This is a measure of what it costs an investment company to operate a mutual fund. Depending on the type of fund, operating expenses vary widely. The largest component of operating expenses is the fee paid to a fund's investment manager/advisor. Other costs include recordkeeping, custodial services, taxes, legal expenses, and accounting and auditing fees. Some funds have a marketing cost referred to as a 12b-1 fee, which would also be included in operating expenses.

Looking At Performance

With the expenses in mind, take a look at the fund's long-term performance. You want to get a sense of how it does when the financial markets are strong and when they are weak. Every investment has its ups and downs, but you want to make sure you can live with the fund's volatility and that the volatility is appropriate for that particular investment. As part of that, you want to compare the fund's performance to an appropriate market index, such as the S&P 500 for a U.S. large company stock fund or the Russell 2000 Index for a U.S. small company stock fund.

This seems like a lot of work, but there are some helpful resources available. Morningstar, a company that evaluates mutual funds, has great information on its website. Many people use a registered agent to help them, too.

Investing involves risk, including potential for loss.

Diversification and asset allocation do not assure a profit or protect against loss. Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations. Bonds are subject to interest rate risk and may decline in value due to an increase in interest rates. The S&P 500 Index tracks the common stock performance of 500 large U.S. companies.


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