How to Buy Mutual Funds: A Beginner’s Guide to Making the Right Purchase

Introduction

You have probably come across the concept of mutual funds while researching the various investment options available in the financial markets. Typically, a mutual fund denotes an investment type that uses money contributed by various investors to purchase several financial instruments. The best thing about mutual funds is that they allow you to expand your portfolio and minimize the costs of purchasing individual assets.

Highlights and Key Takeaways

• Mutual funds differ by their asset composition – classified as equity, bond, and money market funds.

• Investing in mutual funds is a great way to diversify your portfolio.

• Monitoring your mutual fund performance is vital as it helps you make necessary adjustments when market conditions or your financial goals change.

Understanding Mutual Funds

A mutual fund comprises money pooled together from different investors and used to purchase various securities like bonds, stocks, and short-term debt, among others. A professional money manager oversees this blend of investments and decides how to spread the money across industries, sectors, and companies, depending on the fund’s strategy.

• When you buy a mutual fund share, you become a part owner of the fund and qualify to earn from the income it generates.

• The fund’s performance is dictated by the underlying instruments held. So, if their value goes up, the value of the fund’s shares rises. The opposite happens when the assets’ value reduces.

Investing in mutual funds is beneficial since it allows you to access numerous asset classes, including domestic and international bonds, stocks, and more. By having this diversified portfolio, you can increase your potential income and spread risks.

• Generally, transaction costs associated with mutual funds are lower. This is because the fund purchases and sells vast amounts of securities at a go, decreasing the costs you would have incurred by acquiring individual assets.

• Another advantage is that mutual funds are highly liquid, so you can easily sell them.

• Moreover, the funds are well-regulated by financial authorities. This ensures fair practices, and that your interests are safeguarded as an investor.

Betting your money on mutual funds can be risky too. The instruments held in the fund are volatile and susceptible to price fluctuations, which can lead to loss of money.

• Liquidity risk is also real. Some funds can have less liquid securities or market, making it hard to purchase or sell positions.

• During periods of inflation, you may find that your actual returns are lower than anticipated due to the erosion of money’s purchasing power over time.

Types Of Mutual Funds

One of the common types of mutual funds is equity funds. These mainly focus on stocks or equities and are further classified into growth, value, or blended funds.

• If you invest in growth funds, you acquire shares of companies that can potentially outperform the general market, while value funds feature stocks of seemingly undervalued firms. As the name suggests, blended funds combine growth and value stocks.

• Equity funds can earn high returns but are extremely volatile, so you could lose money if you are not careful.

• Bond funds are another type of mutual fund. They pool investors’ money to primarily buy different bonds, including government, municipal, and corporate bonds.

• Bond funds provide the benefit of diversification as they eliminate the need to purchase various bonds individually. Furthermore, most of these funds distribute dividends regularly, which you can reinvest. Perhaps one of the biggest setbacks of bond funds is that they offer lower returns.

• Money market funds are also available for investors. These funds purchase short-term fixed-income securities like treasury bills, government bonds, certificates of deposits, etc.

• The main advantage of money market funds is that they are safer due to low credit risk. They also offer liquidity and pay regular income to investors. Unfortunately, the funds have a lower potential return than other mutual funds.

How To Choose the Right Mutual Fund

As previously discovered, mutual funds differ, so selecting the ideal one is essential. First, consider your financial goals. Do you desire to gain high returns within a short time? Or do you want your funds to increase steadily over time with reduced risk? You must answer these questions to identify the ideal mutual fund for your needs.

• Ensure you consider your risk tolerance level. Do you mind tolerating big swings in your portfolio’s value to enhance your chances of generating higher long-term returns? If yes, equity bonds could be your ideal choice.

• However, if you are a cautious investor, investing in low-risk funds like bond funds is better. Also, be prepared to forego huge returns because such funds generate lower incomes for investors.

• Don’t forget to factor in your desired time horizon. This is the period you want to keep your money invested in a mutual fund.

• In case you want to focus on short-term investment, say less than 5 years, look for more stable funds (e.g., money-market funds) to minimize volatility.

• For longer time horizons, like retirement planning, consider funds featuring growth-oriented assets. This prolonged time span gives you a chance to pull through market fluctuations and leverage compounding returns.

Steps To Buying Mutual Funds

You can easily learn how to buy mutual funds as the process is straightforward. It involves various steps, which are described in detail below:

• Step 1: Decide where to buy a mutual fund. Plenty of options are available, including a mutual fund company, an online brokerage account, or a financial advisor.

• Step 2: Open an investment account. You can check the best online brokers for beginners as a starting point. Fill in the required details and complete any necessary paperwork.

• Step 3: Fund your account using the payment options available.

• Step 4: Buy shares. Once you have located the type of mutual funds you want, place an order specifying the amount. Finalize the purchase and wait for the platform to confirm whether the order was successful.

Fees and Expenses Involved

Mutual fund investment demands certain fees. These costs can significantly impact your overall returns. Higher expenses decrease the earnings received, while decreased costs let you keep a significant proportion of profits, leading to improved returns in the long run. Here are the costs you need to be aware of:

• Expense ratios. This yearly fee helps cover the mutual fund’s operating expenses, such as administrative costs, management fees, and other sundry charges.

• Sales charges. These are fees you pay to compensate a broker or any other financial intermediary for facilitating the purchase or sale of mutual funds. 

• Marketing fees. These are paid to the fund manager to promote the fund or reimburse individuals selling the fund. However, not all mutual funds charge these fees.

• Redemption fees. This is a fee you incur for selling shares from a fund. Its goal is to discourage short-term trading and regular redemptions that can increase the costs of managing the fund.  

• Exchange fees. You are charged this fee for exchanging your assets to another fund provided by a similar fund group.

Before investing in a mutual fund, be sure to check the fees applicable to the funds as each mutual funds stipulates its own fees. Generally, funds with very high fees come with high returns and vice versa. 

Monitoring Your Mutual Fund Investment

Mutual fund investment doesn’t end with acquiring assets. Regular monitoring of some fund’s performance may help you remain updated on current market trends and possible risks. Consequently, you can make necessary adjustments and ensure your portfolio always aligns with market conditions, financial goals, and risk tolerance levels.    

• There are certain scenarios that may prompt you to buy additional units of a mutual fund. A good example is when the market experiences a downturn. Share prices are often lower during such periods.

• Do you want to rebalance your portfolio to retain a particular desired asset allocation? In case the value of some assets reduces, purchasing more units of those instruments can ensure your portfolio aligns with the target allocation.

• Buying more units may also be ideal if the mutual fund demonstrates a steady track record, experienced management, and alignment with your financial goals.

• However, you should consider selling your funds if they consistently underperform to avoid further losses.

• It is also a good time to sell some units when you have achieved your financial goals in order to lock in profits and safeguard your investment. This mainly applies to goals with a specific time horizon.

Conclusion

Now that you have learned how to buy mutual funds, there’s nothing preventing you from acquiring them. Investing in mutual funds allows you to gain exposure to multiple assets at a go, making it possible to diversify your portfolio and spread risks. Some funds can also generate high returns quickly and help grow your income.

Even then, be wary of the risks, such as inflation, lack of liquidity, and price volatility, which could negatively affect your overall earnings. Moreover, ensure you trade mutual funds with a regulated broker to avoid exposure to fraudulent players. While investing in these funds can appear daunting, anyone can master it with research and patience.

FAQ

What are Mutual Funds?

Mutual funds comprise various assets pooled together and managed by a professional fund manager, who makes decisions based on the fund’s strategy and goals.

How Do Mutual Funds Work?

Mutual funds work by aggregating monetary resources from numerous investors. The money is then utilized to buy different assets like bonds, stocks, and other securities. Profits/losses generated from the investments are distributed proportionally among investors after subtracting relevant expenses and fees.