Everything You Need to Know About Mutual Funds
There have never been more stock and bond investment opportunities or information sources available than at the present, but deciding which stocks or bonds to buy has never been more difficult. Equity mutual funds are an alternative to individual stocks and bonds, and they are an easy way to participate in the stock market. They enable the investor to diversify risk and obtain professional management.
The advantage of investing in mutual funds is that they automatically provide diversification.
Even with a small amount of money, investors can own shares of hundreds of stocks or bonds because mutual funds pool money from lots of small investors and a group of professional advisers invests the money in large portfolios with many securities—usually in the stock or bond markets.
There are specialized mutual funds that invest in automobiles, precious metals, utility companies, government securities, and so on, or general funds that cover almost any area in which investors would want to invest.
Keep in mind, though, that like stocks, there are risky funds with high yields and safe funds with lower yields.
Although some investors invest short-term for specific reasons, such as accumulating funds for a downpayment on a home, to be really successful in mutual fund investing, investors must be patient and use the fund as a long-term investment vehicle.
Mutual fund advantages
Mutual funds are both attractive and valuable to small investors. Since many mutual funds require as little as $100 or less to invest, investors’ risks are relatively small and are spread over a large base in the economy.
The number of mutual funds available has multiplied considerably during the past 10 years. This is mainly due to the fact that mutual funds sell well when they perform well and performances on good mutual funds over the past 10 years have averaged more than twice the prevailing interest rates.
However, past history is not always a good indication of what funds will do in the future. Since mutual funds are securities, trained analysts—registered brokers—are best qualified to review funds performances and compare them with current management philosophy, cash position, and market position to come up with reasonable projections of what funds could do in the future.
Choosing mutual funds
To choose a fund, investors should take the following steps.
- Determine their goals. Decide if they are investing for the short term or the long term.
- Use comparative fund listings to identify the best performers over the past 20-, 15-, 10-, and 5-year periods. Never rely on a one-year performance record when selecting mutual funds.
- Research past fund performances against the Dow Jones industrial average and the Standard & Poor’s Index for the same years. Look at the record of funds that have done well in up markets and have conserved their capital in down markets. Choose performers that went down no more than the Dow in poor years.
- Go to independent sources such as the annual review of mutual funds edition of Money magazine and Consumer Reports and compare fund performances.
- All fund companies publish prospectuses showing current financial conditions of individual funds, including administrative costs. These prospectuses should clearly define secure (or low-risk) funds and growth (or speculative) funds.
In order to attract investors in this very competitive field, mutual funds now offer a variety of options. The following are the options most often compared.
When investing in funds, investors generally have the option of shifting or allocating their money into one or more areas within the company’s “family” of investments once or twice a year without penalty. This is now a common option offered by most mutual fund companies.
Open-End vs. Closed-End Funds.
With open-end funds, investors have guarantees that the fund company will buy back shares at whatever market value they are worth at the time of the sale. This gives both liquidity and security.
In a closed-end fund, there are a finite number of shares traded on the open market. They may sell for less than their underlying asset value if there is little demand. There is more risk with open-end funds when it comes time to take a profit, but the return could be more than the return closed-end funds provide.
Load vs. No-Load Funds.
Load funds charge sales commissions up to 8.5 percent at the time they are purchased. No-loads do not. Both charge management fees. The records show that there is no performance difference between the two.
- No-load or non-commission funds allow money to grow without service fees or commissions coming out of the initial investment. In addition, no-load funds normally do not carry penalties if investors decide to withdraw their money.
- Management. Look for funds with consistent management, with a family or a variety of in-house funds, and whose parent company is financially strong.
- Total net asset of funds. Smaller funds that are worth $500 million or less in total assets are likely to perform better than larger funds. Funds where there are huge fluctuations of assets may signal a problem.
- Redemption rate of funds. If funds have massive redemption, either management is having administration problems or the funds are having cash flow problems. In either case, it may be wise to seek alternative investment options.
Millions of investors today put their money in mutual funds. If Christians decide to take this approach and let experts manage their money, they need to make sure they select a good fund. Many mutual funds look good on paper, but loads and fees can erode gains.
In addition, as Christians, we need to understand that some mutual funds invest in areas that are questionable and in some that are blatantly anti-Christian, including pornography, liquor sales, and abortion clinics.
Christians should get prospectuses from mutual funds they’re considering and research the history of the funds to make sure the fund’s goals coincide with theirs.
If you’re looking for more biblically-based direction for your finances, download the Money Map. It’s a free step-by-step guide that will help you set and reach financial goals as you grow as a steward.