Even though investing in mutual funds isn't a topic that brings to mind wild parties and celebrations, serious investors should think about it as a way to add to their wealth.
"But what is a mutual fund?" you ask. "How does it work, who does what, and how much do they cost?"
Hold on, slow down, and please only ask one question at a time.
What is a mutual fund, anyway?
Mutual funds are sold to the public in the form of shares. Depending on how much people invest, they can own a different share of the fund.
Paying more gets you more. When you own more, you get more money back (theoretically)
Simple.
The assets of these mutual funds are used to buy stocks, bonds, money market securities, and other similar financial instruments in the financial markets. The assets in a mutual fund are indirectly owned by the shareholders, but the fund is managed by an investment company that looks for the best way to make the most money. (Because they own the assets indirectly through these funds, they don't have to pay the big tax bill.)
What is the purpose of a mutual fund?
Mutual funds are often called open-ended investment companies as well. This means that they are always giving out new shares and buying back old ones. However, not all mutual funds are open. Some mutual funds are "locked," which means that they will no longer accept new investors.
The key to understanding how a mutual fund works is the Net Asset Value of the fund. By this value, you can always figure out how much a share of the fund is worth. The formula for Net Asset Value is the market value of the fund's assets minus any liabilities, divided by the number of outstanding shares.
If you do that, you can find out exactly how much each share in the fund is worth when you want to invest in it. By looking at this number over time, you can figure out the percentage of return. Most of the time, this is all taken care of for you on a fund's website or on any site for a mutual fund that has stats.
What do they do?
Mutual funds are basically pools of money that take your money and the money of other investors like you and put it into investments that will give you the best return. The returns from the fund are then divided among the accounts of the people who put money into it based on how many shares each person has. The fund managers then take their cut based on the fees you pay them, and you get your return. The money these guys make you is worth it, so why not let them drive the car for a while and take the credit?
Different investment plans are a standard in the field, and they let people invest a set amount every week, month, or however else they want. Accounts that are invested all the time tend to get a higher average return, but you can still make money if you can't do that. Dollar cost averaging should be your goal. It's how the best investors in the country make their money grow.
What does it cost?
There are also different kinds of fees for each type of mutual fund. Some will charge you a part of your investment up front (front load).
Some will charge you a back end load, which is a percentage of the investment when it is sold. Then there are no-load funds, which only charge an annual operating fee. People should try to only use no-load funds because it saves them a lot of money. There aren't many reasons to use a loaded fund unless it gives you a lot of money back. But most of the time, different fund companies offer the same returns.
So look around and compare not only the price but also the service and how well they have done in the past. And don't forget that a mutual fund is still made up of products whose value can go up or down, so don't invest more than you can afford to lose, just in case!
