Mutual funds are a powerful investment tool with a broad range of applications. Thinking about adding one (or more) to your portfolio? Let’s start with the ABCs to cover the essentials!
Like all financial advice, make sure to consult with your family’s trusted financial advisor. I’d like to share these foundational items with you to help with your research and investigation.
What is a Mutual Fund?
Table of Contents
- 1 What is a Mutual Fund?
- 2 How to Invest in Mutual Funds
Mutual funds are broad and diverse. However, at the core, they are all investment vehicles that adhere to a stated financial objective (as articulated within the prospectus). To accomplish this objective, the fund manager will allocate the assets of the fund in accordance with that financial objective. When one purchases a share of the mutual fund, they are effectively buying a piece of that mutual fund “pie,” which is a slice of the larger objective.
What is Mutual Fund in Simple Words
Mutual funds can consist of several types of investments such as stocks and bonds, are created with a stated objective, and professionally managed to accomplish that objective. Buying a share of a mutual fund allows the investor to access a portion of the mutual fund thereby providing the diversification desired without requiring enormous sums of cash to do the same on their own.
Mutual Funds 101
When many investors partake in a mutual fund they are sharing the cost and the benefits accordingly. Fees are spread out and shared; so are any dividends. These fees can be researched in greater detail by reviewing the prospectus, along with other important information on mutual funds.
Think of that piece of the pie – the pie is made up of all the ingredients, not just flour, fruit, etc. In the same way, when one buys a share of the mutual fund they are buying part of the whole fund. One share of a mutual fund is not the same as one share of stock. Different from buying stocks themselves, the investors in a mutual fund forgo voting rights.
NAV Meaning in Mutual Fund
Another difference from stocks, mutual funds are priced with NAV (Net Asset Value). This NAV is calculated at the end of the market day, accounting for any activity, and is derived at that point in time. It does not move around during the trading day (like a stock would). An important part of this is the number of outstanding shares.
Mutual Fund NAV Calculation
The daily NAV value of the mutual fund formula is a simple one! For a per share NAV, this formula is (Assets – Liabilities)/(Outstanding Shares). The NAV is what the mutual fund shares are transacted at and is calculated at the close of the day to reflect the current activity.
How to Invest in Mutual Funds
As you have probably figured out by now, not all funds are created equal. Here are a few ways you can narrow the selection as well as a broad understanding of what some of your options are! Start by figuring out what you’d like to accomplish with your investments. Then, one way of narrowing the scope is to look at and carefully weigh the fee structure, management style, and tax implications of your potential investment.
How to choose Mutual Funds
Firstly, it is important to remember that your particular investment strategy should drive your investment selection. Mutual fund managers are bound to the stated objectives of those funds. As such, the funds themselves can and should be selected to fit your financial strategy.
Funds come in all shapes and sizes, classes and sectors, management styles, fees, minimums, and tax implications (just to name a few). This is why it is so important to set your objectives first, and then look for funds matching those objectives. Afterwards, and as should be the case for any investment choice, make sure to do your homework before investing.
What to look for in a Mutual Fund
After you’ve outlined and defined the strategy, another way to refine the search is to consider the performance of the funds in that particular sector. For example, if you are looking to add a fund that specializes in healthcare, look at several funds in that industry and compare them against each other.
Then, further drill into the differences by looking at things like how the fund has performed historically (remember, past performance is not a guarantee of future results). Also, take a look at the fund manager as well. Are they brand new to the fund? Are there others also managing the fund?
One could also consider the expense ratios, turnover, and tax implications as well. All of this, along with the fund objectives and other important information can be found within the prospectus.
How to Select Mutual Funds
Researching mutual funds can be overwhelming but it gets easier with time! Stay focused on your objective, look at your ratios, get to know your fund manager (not all are equal!), and tax implications. Additionally, think about whether your objective requires active management. Or, if you’re looking for broad exposure, can this be accomplished with a passive fund or an index fund?
With these key pieces in place, a framework in hand, a mutual fund screener can be very helpful to identify the right fund for your portfolio. There are quite a few out there, so don’t be afraid to experiment and see what works best for you. Managing your portfolio takes work and dedication, my friend. Take pride in what you’re doing, keep growing, and keep building Mêtis in your Money Matters! I wish you all the best on your financial journey.
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