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Mutual funds are one of the easiest ways to invest in the market.
Before diving in to mutual fund investment, you should know exactly what they are and, most importantly, how they can make you money.
What are Mutual Funds and How Can They Make You Money?
A mutual fund is a pool of money from many investors – including investors, companies, and other organizations – that invests in securities such as stock, bonds, and short-term debt. The total combined holdings of a mutual fund are called a portfolio.
Each investor buys shares of the fund and becomes a part owner as represented by those shares.
Why Mutual funds are a Popular Investment Option
Mutual funds offer several appealing features and benefits for investors that make them an easy entry-point into the market:
Affordability. Most funds only require a relatively small amount of money to invest upfront and in future purchase transactions.
Diversification. Mutual funds invest in a range of companies and industry sectors, mitigating risk of one company does not do well.
Professional Management. Fund managers do the work for you. They research and select the securities and monitor their performance, taking a significant amount of work of your plate.
Liquidity. Mutual funds are easy to sell – investors can redeem their shares at any time for the net asset value (NAV).
What are the Different Types of Mutual Funds?
Mutual funds typically fall into one of four sub categories:
Money Market funds. These funds carry relatively low risk. Legally these funds can only invest in certain high-quality, short-term investments set forth by U.S. corporations, and federal, state, and local governments.
Stock Funds. As their name indicates, stock funds invest in corporate stocks. They include growth funds, income funds that pay regular dividends, index funds that track particular market indexes like the Dow Jones, and Sector funds that focus on a particular industry such as metal stocks or gold funds.
Bond funds. These funds carry higher risk because the focus is on producing higher returns. They can vary widely.
Target Date Funds. Target date funds are designed for investors with a specific retirement date. They hold a blend of stocks, bonds, and other investments which shifts over time in line with investment strategy.
Mutual funds are further divided along four lines – closed-end and open-ended funds, and open-ended funds are further subdivided into load and no load.
Closed-end funds have a set number of shares issued to the public through an IPO (initial public offering) that are traded on the open market. They are subject to the laws of market supply and demand. Open-ended funds constitute fate majority of mutual funds. Rather than being bound by a set number of shares, open-end fund shares are created and destroyed as needed.
These open-end funds are divided into load vs no load. A load is a sales commission, which the investor pays on top of the net asset value of the fund’s shares. No-load funds have lower ownership expenses so tend to generate higher returns.
How Do You Make Money with Mutual Funds?
Mutual funds produce income in three separate ways:
Dividend payments. When a fund earns dividend income from stocks, it pays the income out to investors, minus fees and expenses.
Capital Gains Distribution. Funds might sell a security that has gained value. At the end of the year, the fund distributes total capital gains minus losses to shareholders.
Increased NAV. If the market value of the fund increases, so does a shareholder’s investment.
The Benefits of Mutual Funds
Because mutual funds are managed by professionals, they remove the stress individual investors face from analyzing statements or calculating financial ratios or returns.
Mutual funds come in many forms, so it is vital that you find a fund that fits your individual investment criteria and style. The most important factor is knowing and understanding your investment. For example, if you are familiar with metal stocks, gold funds might be a wise choice.
Once you narrow down your investment targets, you can go out and search for the best gold ETF or the best index fund. Morningstart or Standard and Poors issue fund ratings based on past records. Bare in mind that while they give a reasonable indication of fund success, they cannot predict the future.
You can purchase funds much as you would a stock. Most funds have a minimum initial investment which can vary widely from as little as $25 to upwards of $100,000, but most settle in the range of $1,000-5,000. These minimums may be lowered or waived if the investment is for a retirement account such as a traditional or Roth IRA or a 401k.
How to find the best gold ETF
Because gold prices are governed by different economic forces than other asset classes, gold funds are a great way to diversify your investment portfolio. One of the most common ways to invest indirectly in gold is through an ETF such as SPDR Gold Shares (GLD). In terms of long-term performance, some of the best gold mutual funds include the Tocqueville Fund and the Gabelli Gold Load-Wiaved.