What You Need to Know to Invest in Mutual Funds

Find out the answer to "What are mutual funds?" and learn how investing in them can enhance your portfolio.

A number of factors go into selecting the right mutual fund. As with any investment, you should thoroughly research any mutual fund you’re considering to make sure it matches up with your risk-return profile. Before you start investing in mutual funds, ask yourself these questions:

  • How can I invest in a mutual fund?
  • Open-ended mutual funds, closed-end funds and exchange-traded funds: Which is right for me?
  • What types of fees do funds charge?
  • What are the benefits and risks of mutual funds?
  • Are there “all-in-one” types of mutual funds?

As you keep reading and start learning the answers to the above questions, you can prepare to invest in mutual funds.

How to Invest in Mutual Funds

Options for investing in mutual funds include working with a broker online or in-person, or entering trades online yourself. Depending on which method of investing you choose, your experience could vary. Here’s what to expect when initiating an investment in mutual funds:

  • If you work with a full-service brokerage firm, such as UBS or Merrill Lynch, you can get help in picking out a fund and have your broker enter an order for you. These firms also have online interfaces where you can enter your own orders, if you so desire.
  • If you’re working with a discount or online broker, such as Charles Schwab, you can enter your own mutual fund trades online. Schwab offers an extensive lineup of no-load funds in addition to other investments.
  • Or, if you prefer speaking with a live person, you can call or visit a Schwab broker. For an additional fee, the broker can enter a trade on your behalf.

See: Top 7 Characteristics of the Best Mutual Funds

Types of Mutual Funds

With an open-end fund, you buy shares directly from a fund company. If you want to sell your shares, you redeem them with the issuing company. Shares are priced once daily — after the close of business — based on the value of the underlying assets.

A closed-end fund offers shares to the public once, then trades on a stock exchange. If you buy shares of a closed-end fund, you purchase them directly from a selling investor. You can buy or sell closed-end fund shares when the stock market is open.

An exchange-traded fund acts much like a closed-end fund in that it trades on an exchange. Unlike closed-end funds, ETFs cannot issue debt or preferred shares. Closed-end funds also tend to be actively managed, unlike ETFs, which are often index funds tied to the performance of an index, like the Standard & Poor’s 500 index.

Related: ETF vs. Mutual Fund: Which Should You Choose?

Mutual Fund Fees

The most obvious type of mutual fund fee comes in the form of an upfront sales charge. Some mutual fund companies charge a fee of 5.75 percent or more of your initial purchase as a commission, with the balance being invested into the mutual fund. You can avoid this fee by purchasing a no-load fund — popularized by companies such as Vanguard — that charge nothing at all by way of a commission.

However, even no-load funds charge ongoing expenses to pay for day-to-day fund management. Some funds also charge distribution fees, known as 12b-1 fees, which are incorporated into the overall cost of a fund. Most of a fund’s expenses are reflected in a percentage known as an expense ratio.

Pros and Cons of Investing in Mutual Funds

One of the main benefits of mutual funds is access to professional management. When you buy a mutual fund, you own a portion of a collective pool of money that is invested on the behalf of shareholders by a money manager. When the manager makes good investments, all mutual fund shareholders share in the profits.

The second main benefit of mutual fund investing is diversification. With one investment, you might own a share of hundreds of different types of securities. If you’re just starting out with a few hundred dollars, you couldn’t get that type of diversification by investing on your own.

On the downside, when you buy a mutual fund, you own what the manager chooses for better or worse. You have no control over the individual security selection within the fund. You also have no control over the tax situation of the fund. If the manager decides to sell a lot of stocks with large gains, for example, you’ll get a taxable distribution of those profits, even if you don’t sell shares in your fund.

Mutual Funds as an Investment Portfolio

If you don’t want the headache of monitoring more than a single investment, some funds can offer a type of all-in-one approach. One type of such fund is a target date fund, which adjusts its portfolio as it progresses towards its termination date. Typically, target date funds will reduce the amount of stocks they hold and increase their bond allocation in a bid for a more conservative allocation over time. As these types of funds are designed to mimic a shareholder’s lifecycle, they are also known as “lifecycle funds.”

Up Next: Should a Mutual Fund Be Your First Investment?