New investor here. I wanted to use this place as a platform for boosting my investment education. It’s no secret that I’m pretty green when it comes to the world of investments, but I’m making some progress. Or at least I thought I was until I started digging into mutual funds. I thought that a mutual fund was actually another type of investment product, like a stock or a bond, but apparently I couldn’t have been farther from the truth.
The reality is that a mutual fund is nothing more than a collection of investments that are alike in scope that are managed by a fund manager. Since my main focus is on stocks, we’re going to focus on equity mutual funds since these are simply a collection of stocks.
The Basics of Equity Mutual Funds
Okay, so many of you are probably wondering why anyone would want to invest in a mutual fund and be at the mercy of the mutual fund manager instead of engaging in stock picking and investing in individual stocks that they themselves choose. But, from what I can gather, your money is actually pooled with the cash from other investors, which gives the fund manager greater buying power and influence when it comes to buying and selling investment stocks, AND mutual funds are required by law to distribute almost all of its gains every year, giving you (the investor) much more money in your pocket in terms of dividends.
Plus, mutual funds have a more expansive oversight process which protects investors from unscrupulous fund managers since most are overseen by a board of directors or trustees. You can’t get that kind of security from a typical common stock or preferred stock purchase.
An equity mutual fund is generally classified by the size of the companies it holds stocks in. Oftentimes you see these funds referred to as High Cap Mid Cap and Small Cap funds. (Now, I finally get what those terms mean in terms of my 401(k))! High cap funds are the big boys that tend to be more stable and experience a more regular, less dynamic rate of growth. Small cap funds refer to funds that target the small publicly held businesses that tend to be more growth oriented and therefore somewhat more risky. You can also get involved with “specialty funds” that invest in the stocks of healthcare companies only or real estate. And you can invest in domestic and international equity mutual funds, which is nice for diversity’s sake.
The idea behind investing in equity mutual funds is to weigh risk against rate of return. What I mean here is that if you are the type of investor who simply can’t stand the thought of losing one penny in the stock market or if you are close to retirement, you are considered a conservative investor and should probably stay locked into investing in high cap mutual funds that provide a more stable, less volatile return on your investment. However, if you are in a position where you can ride out the inevitable ups and downs of the stock market, you might think about putting some of your money in small cap or growth oriented funds. These funds have a greater potential for loss, but also have a lot of room for growth, which equates to a huge rate of return for you. Usually investors that have twenty years or more before they need to draw on their investment earnings can do fairly well with small cap mutual funds.
One of the best benefits of investing in a mutual fund is that you, as the investor, only have to decide what your risk threshold is before you choose a mutual fund to invest in. Of course, you need to do your homework on the mutual fund manager and the past history of the fund, but you don’t have to get into the nuts and bolts of trying to pick individual stocks. A lot of 401(k)s rely heavily upon mutual funds to provide investment options for their clients. I would suggest that first time investors who have 401(k)s take a closer look at the mutual funds available through their retirement plan and shift money around a little in order to see what the impact of certain decisions are on earnings potential.
Created June 6, 2010. Updated December 9, 2011. Copyright © 2011 The Digerati Life. All Rights Reserved.