What is a Mutual Fund?
A mutual fund is an investment vehicle designed for the purpose of investing in a variety of assets including stocks, bonds, money markets, and other assets. Mutual funds are professionally run and operated by money managers who charge a fee for their services. The funds charge fees in a variety of ways. Some funds have an up-front fee, then charge an annual maintenance fee, other (no-load funds) do not charge an up front fee, but may/may not charge a higher annual maintenance fee, others charge a back end fee upon distribution. The various fee schemes can sometimes make it difficult to compare funds across the board. However, these fees are extremely important in considering the overall performance of the funds and how much of a return you will actually earn on your money.
What Companies Offer Mutual Funds as Investments?
There are some excellent companies including Vanguard which specialize in low cost funds which have had successful long term performance (compared to many other popular funds) at a low cost structure (meaning you retain and reinvest most of your gains, providing you with more compound growth). T. Rowe Price is another mutual fund powerhouse which offers many excellent mutual funds for investors in my opinion. The United States Securities and Exchange Commission offers a free mutual fund fee analyzer tool directly on their site. Click here to check it out.
Mutual funds are preferred by many investors over individual stock picking due to the fact that they are:
1) professionally managed: allowing you to sit back and invest, leaving the professionals to manage the money and work to keep performance in line with expectations.
2) Diversified: they are typically much more diversified than an individual investors stock portfolio.
Diversification is where you own a broad variety of assets/asset classes in order to try to reduce risk/exposure to negative events or the risk of one negative event or poorly performing investment ruining the overall returns of your portfolio. For instance, if you owned only one stock and that one stock was a technology company heavily dependent upon Apple computer company for a large percentage of its annual profits/business, if Apple decided to cut a majority of its business with that company (due to having found a cheaper supplier/more reliable supplier, etc.) then the stock of your one investment would fall dramatically leaving you with terrible returns/negative returns for the year.
However, if you had diversified in advance, and owned 10-15 different companies with various risks of exposure in various industries, your one stock which fell by a large percentage due to Apple switching its supplier, would not affect your overall portfolios returns so much. This is why diversification is considered to be a good thing, it reduces your risk of exposure to one or more negative events.
Are Mutual Funds Taxable Investments?
Mutual Funds are taxed similar to other stock/bond investments, meaning you are taxed on both dividend earnings, and profits/capital gains (short term/long term). However, you can also own mutual funds in tax advantaged accounts such as 401k’s, Roth IRA’s, Traditional IRA’s, and SEP IRA’s. It is preferable to invest in tax favored accounts when possible for money you intend to grow for your future as long term investments, due to the compound nature of the growth (avoiding taxation each year on earnings, or upon the sale of investments). In a tax preferred account the money can be reinvested after selling for a gain, instead of taxed, thus allowing for additional earnings on the prior profit (as opposed to having that money go towards taxes). The money is instead simply taxed upon withdrawal when retirement age is reached (early withdrawal is subject to regular income tax in addition to tax penalties). For these reasons tax preferred accounts offer excellent advantages over traditional brokerage accounts for long term investments and to grow wealth over time. These benefits should not be overlooked.
Mutual Funds can be a great investment for long term wealth building. As always the preferred method for building long term wealth should be in tax deferred retirement accounts. However, mutual funds can also be a great investment in a standard brokerage account, but you may have taxes on any gains due to fund trading, dividends, etc. Important considerations with mutual funds are past performance, and annual fees charged. The past performance can sometimes give you a glimpse of how an investment may perform in the future (if it has a solid 5-10 year record). However, you still should be aware that tops funds one year, will likely not top the list the next year, therefore try not to buy at the peak. Additionally, paying attention to fund fees can have a huge effect on your long term investment performance as funds with up front or large annual fees are taking away from monies invested and both time invested and fund percentage performance on an annual basis are typically the largest factors affecting your future account balance (10, 20, or 30 years down the road). These considerations should not be over looked. If you make the decision to invest, take care of your money and do it right. Don’t blindly pick a fund, do some basic research first, be confident with your decisions, as it is your hard earned money you risk and allow professionals to manage.