In our last blog post we discussed the fundamentals of investing based upon risks versus rewards. Now we can move into the interesting topics dealing with what kinds of investments should we consider. Let’s skip over stocks and bonds with just the simple point that while there are many kinds of each, in general, long-term investors buy some of each so they can combine the relative safe, but low yielding bonds with the potential for bigger rewards, but more volatility from stocks. Buying a number of different investments, especially both stocks and bonds, provides diversification with the goal that if one investment or type of investment is doing badly, the others will be doing better. How you diversify your savings among different investments is called asset allocation. The easiest way to get a wide range of diversification is to invest in mutual funds and exchange traded funds. Today let’s begin discussing mutual funds and cover what they are and the types.
What are mutual funds
A mutual fund is a professionally managed investment company that pools investors’ money to buy an assortment of stocks, bonds, money market instruments, real estate, and other securities generally based upon a particular investment style. Investors buy shares from the mutual fund company or brokers rather than exchange shares with other investors like stocks. The fund will continuously issue shares to meet demand or until managers decide to stop issuing new shares because the fund gets too big to manage well. The price for shares of a mutual fund fluctuates as the securities it holds fluctuate, but is set once per day after trading hours. The price is called the fund’s net asset value (NAV). There are funds called “closed end” funds that issue a set number of shares in an initial offering similar to a company issuing stock. They have special trading considerations that you should research carefully before investing.
You can purchase some mutual funds directly from the fund company while others can be purchased thru your stock broker, bank, financial planner, or even insurance agents. Stock brokers’ mutual fund fees, selections, and policies can vary widely so this may be one area you want to review carefully when selecting your stock broker. There are many big companies called fund families that offer a wide variety of mutual funds. Some investors like to pick the best from each company while others like the convenience of being able to exchange funds primarily within one or two fund families.
Types of mutual funds
There are basically three types of mutual funds: money market, bond (fixed income), and stock (equity); but there is an almost endless variety of combinations, sub-categories, and investment styles.
Money market funds – These funds may only invest in high quality, short term investments from US corporations and Federal, state, or local governments. They try to keep their NAV-price at $1.00. Since the price rarely changes, your return comes solely from dividends which are in the same low range as savings accounts, CDs, and money market accounts. Note that “money market FUNDs” are not the same as “money market ACCOUNTS” even if a bank is offering the mutual fund. Money market accounts usually at banks are federally insured like other bank accounts while money market funds are not – just as other mutual funds are not.
Bond funds – These are also called “fixed income” funds and you can find a bond fund for nearly every type of bond including treasuries, foreign, municipals, high quality corporate, high yield (junk bond) corporate, short/intermediate/long term, convertibles, mortgage backed, and many more.
Stock funds – Also called “equity” funds, you can find many types including growth, value, income, every kind of sector/industry, global, international, emerging markets, regional, country specific, index, target date, small/mid/large cap, balanced, contrarian, bear market, and many more.
Next we will discuss benefits and negatives of mutual fund investing.