How to Invest in Mutual Funds

Daniel Penzing
Written by
Last update:

Diversify your investment portfolio with mutual funds.

Mutual Funds are one of the most common investment vehicles for a variety of reasons. They allow for broad diversification, give investors the flexibility to meet their specific needs, and are easy to purchase. Narrowly investing in only one area can leave you with quite a big risk: your portfolio is tied up in one company or one sector. When financial conditions change, your investment could lose a lot in value.

Using a mutual fund, an investor can place a safe bet without sacrificing growth. Mutual funds are composed typically of 200 stocks or more, and the amount of money invested through the fund determines how big the stakes are. Mutual funds are also managed by experts that analyze the markets and ensure that your investment stays sound and does not fluctuate based on the market.

Scared of investing when the economy is bad? Don’t be! Mutual Funds can be purchased through a fund company or an investment bank. These companies collect money from investors, and once the total amount of money meets the mutual fund’s threshold, they are able to purchase the stocks or assets that the fund will invest in.

When the economy is bad, consider buying a Mutual Fund in sectors or industries that are performing well through the bad times. If others are avoiding the sector, you could have the sector to yourself and make a killing when the economy improves.

Identify Goals and Risk Tolerance

Before you start any mutual fund investment, you need to identify your goal and tolerance to risk.

Emergencies or sudden expenses can deplete your investment amount if you are not careful.

A large fund investment will also impact your monthly cash flow.

Before you invest your money, you need to know your options:

  • Cash & Security
  • Liquid
  • Growth
  • Debt Securities
  • Fixed Interest
  • Property
  • Equities

Most people have a combination of assets. You should now put your assets according to your asset allocation.

The initial decision to make is to choose between strategically investing and speculating.

If you are strategic and you invest in shares that can earn consistent average returns, then you are more likely to keep your cash secure.

If you gamble your money with speculative investments, you are more likely to lose your money.

The second decision is to know your time horizon.

Which is how long do you keep your money invested for.

It can be a day, a month, or up to years.

If you’re investing for a short period of time, you need to be more cautious and scale down to lower-risk investments such as cash and a safe investment.

If you’ve got a longer investment horizon, you can take greater risk with equities and growth investments.

Choose Between Passive and Active Funds

Trading in the stock market for a living is more like playing a video game than an actual job. The stock market moves at all hours of the day, sometimes unpredictably and sometimes very predictably. Just like video gamers, many investors create automated trading strategies based on historical patterns.

When you’re trading in the stock market to earn money for a living, you’re usually trying to do something that will compound in value over a long period of time. That means you’re less interested in an individual company and more interested in a group of stocks called an index. An index is a group of stocks that are organized according to type of company that has a representative sample of all the companies that are publicly traded. Diversified indexes are great because you can earn money no matter which direction the market goes without having to predict the market.

These kinds of market trades do have the potential to make you a fortune, but they also come with some serious risks. Some people might be interested in putting their money into these kinds of investments, but there is a lot to learn before you can do this.

Learn about the Traded Market

Learning how to trade in the stock market to earn a living can be very difficult. You’ll need to be able to do things like look at a price chart on your smartphone and have an understanding of the flows of the market.

What's the difference?

A mutual fund is basically a collection of many, many stocks that have been purchased and grouped together so that doing all the trading and paperwork isn't so hard. When you invest in a mutual fund, you become a part owner of the stocks in the mutual fund.

A closed-end fund is a mutual fund with a fixed number of shares in existence. Once those shares are purchased, no more will be made. And the value of the mutual fund goes up as the value of its stocks go up, and vice versa.

An exchange-traded fund is a type of open-ended mutual fund that trades much like a stock. Rebalancing happens within the fund, and there is no limit to the number of shares available.

What to look for before buying into any actively-managed mutual fund

If you have any amount to invest, you should know that you could make your wealth grow faster if you invest in mutual funds.

The problem is that most of us need financial advisors to help us figure out how to invest in mutual funds. Even if you know how to invest in mutual funds, you will need financial advisors… to tell you what mutual funds to invest in!

Of course, that is true only if you get into actively-managed mutual funds. The benefits of actively-managed mutual funds are debatable and you may end up with a bad experience. So don’t invest in them.

Instead, invest in passive index funds. Although passive index funds are not actively managed, they have the potential to give you a higher return.

If you are still not sure about which mutual funds to invest in, check out our infographic below.

If in any case, you are new to mutual funds, start with SIPs or systematic investment plans. SIPs make it very easy to invest because you will have to do nothing at all, as your money is regularly deducted from your bank account and invested in various mutual funds.

If you are new to mutual funds and don’t have the time or resources to do your own research, follow the suggestions of a financial professional.

Decide on Fund Types and Styles

One of the primary distinctions among the various types of mutual funds is whether or not they actively trade in an attempt to generate higher returns. Actively traded funds are called "actively managed" funds, and in general it is best to avoid these. That's because it's easy for a fund manager to get lucky…just as it's easy for him to get unlucky and blow up your portfolio. By far the most important decision you will make when purchasing mutual funds is to identify the best way to allocate your assets, whether it be in passive index funds or actively traded actively managed funds.

Take Your Mutual Fund Buying Advice from the Experts

What does the average investor know about mutual fund investing? Very little, and that's exactly why they need to rely on the advice of the professional money managers out there who are in the business of selecting and managing mutual funds. If you want to invest in mutual funds yourself, are looking to achieve some comfort with the many different choices available, or want to really maximize your potential returns, all you need is a financial planner who understands how to invest in mutual funds. A pro can help you choose the best money funds and funds for your portfolio, showing you the way to achieve your goals not by borrowing money but by using the power of compound interest, buy and hold strategies, and diversification.

Calculate Your Mutual Fund Investment Budget

Before you start investing in mutual funds, there is one very important thing you need to decide: How much you are willing to put into the mutual fund investments and how often will you do it? Once you have decided the amount, you can then consider how frequently you will invest in mutual funds.

There are many benefits to investing in mutual funds. While saving money is great, it does not usually give you the option to invest in diverse investment options, unless you have a significant sum that can be put aside for higher returns. Mutual funds give you the best of both worlds because you can invest in them even with a little money. You can add money to your investments anytime and start building a long-term plan for your money.

Mutual funds have given a great option for investors who want to maximize their money in a short span of time.

Choose the Right Brokerage for Your Mutual Funds

You’re not required to apply directly through the mutual fund companies themselves. You can open your mutual fund account through any brokerage or financial institution.

You also have a variety of options when choosing a brokerage firm:

  • Full service brokerages
  • Financial advisors
  • Discount brokerages

Some of the leading mutual fund companies have their own brokerages, and you may find one that serves you best as a branch or representative of a specific investment firm. You can also use a brokerage that specializes in mutual funds as a one-stop shop for all of your investment needs.

Discount brokerages don’t provide personal financial services. They simply enable you to trade investments, including mutual funds, online. You’ll be able to access the same investments and funds you would through a discount brokerage. They just won’t be able to advise you on the best investment choices.

Whatever brokerage you choose to use, you’ll want to work with an advisor who is familiar with mutual funds – either directly or indirectly through a mutual fund company. A specialist in holding companies and portfolios can steer you in the right direction.

If you’re considering using a financial advisor, researchers from Bloomberg, the Mint, and the University of Georgia recommend asking these questions:

Understand and Scrutinize Mutual Fund Fees

Remember that nothing in the world is free, and you will be paying brokerage fees for all kinds of transactions. The same goes for mutual funds.

Before you invest in a mutual fund, it is important to consider the associated fund expenses. Read this fact sheat of top mutual funds to find out the average expense ratio across all mutual funds in the industry.

An exchange-traded fund (ETF) is in many ways similar to a mutual fund. The major difference is that an ETF trades like a stock on an exchange. That means its price changes throughout the day as it is bought and sold. The price of an individual ETF share is based on the value of the holdings in that ETF. For example, an ETF with oil stocks will have a higher price than one with shares of the tobacco industry. ETFs have lower expenses than mutual funds.

You should also look at your fund’s expense ratio as compared to its turnover rate. Mutual funds with high turnover rates can have high levels of taxable capital gains. High turnover rates also increase a fund’s risk.

An expense ratio will tell you how much you pay to own a mutual fund. It is expressed as a percentage of the fund’s average net assets (net assets are the total value of the fund’s holdings minus the fund’s liabilities).

Build and Manage Your Portfolio

While you're busy trying to maximize your profit, don't neglect the life within your investments. Mutual funds are just more investments, no matter how they're dressed up.

We're all about performance in the stock market. It's what we get paid to provide. Because we can't deliver performance if we don't say anything about your fund's investment process, and because fund managers and salespeople tend not to say much, the same situation persists in the mutual fund world.

So, one of the things we do is discuss mutual fund investment processes with fund managers on a regular basis. And they are more open than you think.

Some of them know their implementation is just plain different from what they would do if they were managing their own money. Although that is a pretty major conflict of interest, these guys at least know how to do what they're supposed to do. And that's to keep their fund's mandate alive and well. But that takes some doing. Yesterday's killer strategy can turn into tomorrow's bottomless pit.

  • Some funds regularly chortle as they pay up for assets that aren't worth anything.
  • Some funds sell winning stocks while they're still winning.
  • Some funds do the opposite with middling stocks.
  • Some funds continue to buy hot stocks long after the portfolio has run out of money.

Anyone Can Invest in Mutual Funds

Mutual funds are easy to invest in because they are investments of which many people have owned shares and have collected dividends from for years now. Mutual funds are essentially a pool of money that is combined together to buy stocks, bonds, or other types of investments. The investment is managed by a professional who is paid to manage the money. This way, you don’t have to concentrate on buying individual stocks or bonds. You will own shares of the mutual fund and will eventually receive dividends from the investment.

Mutual funds are a great way to invest because they have historically shown a rate of return that is higher than the average. They are also different from other ways to invest, like buying individual stocks, in the sense that if something goes wrong, your money is still protected under federal law. The main goal of a mutual fund is to make money for you. They also let you cut down on the risk that you are taking with your money.