Unless you’re rich and can afford expert investment advice, you’ve probably wondered a bit about mutual funds.
You’ve seen ads for mutual funds on television, and perhaps you’ve read ads for them in newspapers. And every once in a while, you’ll see a business or personal finance magazine with a cover touting that publications annual guide to mutual funds.
If you’re an investment junkie, this information glut is nirvana. You know who you are: You’re the sort who studies interviews with portfolio managers, and you have the last six months of “Wall Street Week” on tape.
But if you’re like the rest of us-investment neophytes-this tidal wave of verbiage only serves to intimidate.
Don’t panic: We’re here to help. Names like Peter Lynch or Mario Gabelli don’t have to trip off your tongue to learn the basics about mutual funds.
The first thing you should know is that there are more than 4,000 mutual funds. Of course, this bewildering array of choices makes it even harder to pick the fund you may want to buy. But we’re going to give you the information you need to at least sift through the roster.
This is intended to be “A Beginner’s Guide to Mutual Funds.” Its purpose is to help you understand what mutual funds are, how they work, and why they’re the most popular investment today.
One word of caution: Before investing in any of these or any other fund, it would be wise to check with your broker or financial planner, or someone you trust who understands investments, to help select which fund is the most appropriate.
And now, 10 questions about mutual funds that you might have been afraid to ask:
Q-What is a mutual fund?
A-A mutual fund pools money and invests it in stocks, bonds or money-market instruments. In exchange for giving a fund your money, you get shares of the fund.
The underlying philosophy is that bigger is better. If you had $100 million to invest, you could afford to hire the best investment advisers. But if you got 100,000 people together, and they each put up $1,000, you’d have the same clout as someone with $100 million.
Q-How much money do I need to buy a mutual fund?
A-Probably less than you think. If you can scrape together $250, you have enough money to choose from hundreds of funds. Other funds require minimum investments of $500, $1,000 or even $10,000. But once you’re in a fund, many will accept further investments as low as $25.
Q-Are mutual funds a safe investment?
A-Unlike the money you put in a bank, the money you put in a mutual fund is not insured.
Secondly, the volatility of funds varies widely. Funds do not offer a fixed rate of return. The yields and values of the securities a fund buys will fluctuate, and so will the returns.
Q-How have mutual funds performed?
A-Equity (stock) funds on average did not beat the compound annual gain of the Standard & Poor’s 500 stock index in the 10-year period ending January 1993, according to a survey by Money magazine. Mutuals also did not beat the S&P at the five-year mark.
On average, equity funds only topped the S&P at the three-year and one-year intervals.
But this does not mean that you should not consider buying a mutual fund. Money magazine compared the performance of all equity funds, some of which beat the S&P 500 by a wide margin and others that didn’t fare so well.
Q-What’s the difference between load and no-load mutual funds?
A-One of the ways people who sell funds make their money is through load fees. Loads are essentially commissions. If you buy a mutual fund from a broker or a financial planner, you’ll pay an upfront fee of up to 8.5 percent.
You can avoid a load fee by buying a no-load fund, which does not charge a sales commission because it is sold directly to the consumer.
However, all funds charge management fees, which range from 0.5 percent to 1 percent.
Q-What is the difference between a closed-end and an open-end fund?
A-Open-end funds keep issuing shares whenever someone buys them. Closed-end funds have a fixed number of shares.
Most funds are open-ended. The advantage of that is when you want to sell your shares, you don’t have to find someone else who’s willing to buy them. The shares are just extinguished.
Closed-end funds don’t have to keep any cash around to pay off investors who are redeeming their shares; they can have all of their assets fully invested. Shares of closed-end funds also trade at a premium or a discount of the underlying per-share value of the fund’s portfolio.
Q-What is a 12b-1 fee?
A-The 12b-1 refers to a Securities and Exchange Commission rule that allows funds to charge for marketing costs.
The justification for these fees is that if a fund is able to lure more investors, it will have a larger base over which it can distribute its costs. This is supposed to result in lower upfront fees, but several studies have shown this is not always the case.
Q-What is net asset value?
A-Frequently abbreviated to NAV, net asset value is the total value of a fund’s assets divided by the number of outstanding shares. Both numbers change each trading day, so NAV is a handy measure to see how your fund is doing.
Q-What is dollar-cost averaging?
A-Obviously, you’ll want to buy shares in a fund when they are low in price and sell them when they are high. But how low is low and how high is high?
The solution is dollar-cost averaging, which means you put equal amounts of money in a fund at set intervals. If, for example, at the end of every month you put $50 into a fund, some months you’ll get more shares for your money and some months you’ll get fewer.
But after a year, the average price you paid for your shares will be less than if you bought all of them at a time when the share price was high.
Q-How can I find out how my fund is performing?
A-Many newspapers, including the Chicago Tribune, publish mutual fund charts every day, except after a holiday when the markets are closed.
A glossary
– Balanced fund: A fund that buys common stock, preferred stock and bonds in an effort to obtain the highest return, but at low risk.
– Growth fund: A fund that invests in growth stocks. These are stocks that are expected to increase in price rather than in dividends. Usually denotes higher risk.
– High quality/high yield: The first refers to bonds rated AA or AAA by Standard & Poor’s or Moody’s, which means the bonds are relatively low risk. High yield refers to bonds rated BBB, Baa or lower. This means the bonds are of medium grade or speculative. These pay higher yields but carry greater risk.
– Income fund: A fund whose goal is to generate current income rather than appreciation in price. Usually denotes lower risk.
– Index fund: A fund whose portfolio matches that of a broad-based market index, such as the Standard & Poor’s 500, and whose performance matches that of the market as a whole. Usually lower risk.
– Small capitalization: Refers to companies whose market values in stock are less than $1 billion. Sometimes used to denote companies whose market values are less than $500 million. Considered more risky than investments in companies with market values above $1 billion.
