Investor’s Guide To Mutual Funds

Key Takeaways

  • A mutual fund is a collection of money that is invested by a portfolio manager on the behalf of individual investors.
  • Factors to consider when deciding between real estate and mutual funds include your rate of return, risk, taxes, leverage and control.
  • Be sure to educate yourself on the different types of mutual fund products available.

Getting your start in investing has gotten a lot more accessible in the last decade, with the proliferation of user-friendly brokerages, funds and trading applications. However, there are so many investment options out there: real estate, stocks, bonds, commodities and mutual funds (to name a few examples). Today’s discussion will help bring you up to speed on the last category—mutual fund investments—to help you decide if it’s the right investment option for your financial goals.

What Is A Mutual Fund?

Mutual funds are collective pools of money that have been invested by individuals. Money managers take these funds and invest them in different securities, in a way that focuses on either long-term growth or high pay-offs while minimizing risk as much as possible. Because these funds are a collective, each shareholder will benefit or lose equally. However, those who select a mutual fund investment over individual stocks or bonds typically enjoy less exposure to risk, as they are diversified between different types of securities.

To invest in a mutual fund, you can typically buy shares through a mutual fund company, brokerage or bank—many of which are available online. Many individuals will use their 401(k) provided through their workplace to invest in mutual funds, as a way to save up for retirement. If you fall into this category, be sure to avoid these common retirement investing mistakes. Once you have purchased your shares, your dividends and interest are typically reinvested on your behalf, unless you specify otherwise. You also have the option of earning capital gains by selling your shares for more than you paid for them.

Earlier, we mentioned that the mutual fund manager will make investment decisions based on the nature of the investment fund type. Be sure to review the different types of mutual funds below, so that you can select one that best aligns with your investment goals.


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Mutual fund investment

Types Of Mutual Funds

  • Money Market Funds: This type of fund is a great fit for investors who don’t mind having a lower potential return, in exchange for safe investments. Money market funds typically invest in government bonds, treasury bills, certificates of deposit and other short-term fixed-income securities.

  • Fixed Income Funds: Government bond, investment-grade corporate bond and high-yield corporate bond investments are known to pay out a fixed rate of return, mostly through interest. It should be noted that funds that invest in high-yield corporate bonds tend to be riskier than government and investment-grade bonds.

  • Equity Funds: Equity funds invest in stocks with the goal of helping your investments grow faster than they would with money market or fixed income funds. However, there is always a higher risk associated with funds that focus on higher yields or faster growth. Investors can choose between growth stocks, which do not pay dividends and are focused on long-term growth, or income funds, which do pay dividends.

  • Balanced Funds: Those who wish to earn higher returns but still want to minimize risk as much as possible should consider balanced funds. These funds invest in a mix between equities and fixed income securities by following a special formula, and are associated with less risk than pure equity funds.

  • Index Funds: Index funds will go up and down based on the performance of a specific index, such as the S&P Index. Because the manager for this type of fund does not have to actively research or make investment decisions, these funds typically come at a lower cost.

  • Specialty Funds: Investors who are interested in specific niches, such as real estate, certain commodities, or even socially responsible investing might consider a specialty fund.

  • Funds-Of-Funds: A fund-of-funds will invest in a way that is similar to balanced funds by allocating assets and diversifying in a way that minimizes risk but still focuses on higher returns. These funds are unique because they invest in other mutual funds. Because the portfolio manager is required to perform intensive research, these funds typically have higher costs and fees.

ETF Vs Mutual Fund

When researching different types of mutual funds, you will likely come across the term “ETF.” These two investment types are often grouped together because they both involve pools of cash that are invested in varieties of assets. However, there are some important distinctions between the two. ETFs, or exchange traded funds, track a particular index of the stock market and are traded throughout the day. In contrast, mutual funds are traded at the end of the day at their net asset value.

Both ETFs and mutual funds have unique advantages and disadvantages that will cause an investor to choose one option over the other. For example, one investor might choose an ETF if they prefer to have more control, as they are able to trade throughout the day and place a variety of orders. In addition, ETFs are generally associated with lower investment minimums and fees.

However, an investor who prefers to trade without paying commission, and prefers a fund that is actively managed, might opt for a mutual fund instead. Ameritrade offers a great side-by-side comparison of ETFs vs mutual funds, as well as a discussion of the pros and cons of each.

Real Estate Vs Mutual Funds: Factors To Consider

Now that you have a better grasp on how mutual funds work, you have a big decision to make: Will you invest in mutual funds or in real estate? There are a variety of benefits of investing in real property. For starters, you are building equity in something tangible, an investment secured by a physical asset. Furthermore, during any type of economic downturn, you have equity built in and can keep earning cash flow from rental properties. Also, don’t forget about the added appreciation you get to factor in. If you’d like to get started in real estate investing, here’s a beginners guide to everything you need to know.

On the other hand, there are a myriad of unique benefits associated with mutual funds, some of which you have hopefully gleaned throughout this piece. Here are some important factors to consider when making your decision:

  • Rate Of Return: One of the main considerations for investors is the rate of return on their investments. Funds and brokerages will provide projected rates of return for the various products they offer. Calculating the rate of return on real estate investments can be trickier, as you won’t necessarily know your return until the property is sold or rented. Here are tips on how to calculate your return on investment (ROI) and cash-on-cash return for real estate.

  • Risk Factor: The performance of both real estate and mutual funds are dependent on the economy. Some may argue that mutual funds are less risky due to portfolio diversification, but they are still subject to economic downturns. Others will argue that individuals have more control over real estate risk by minding their due diligence. In addition, they can still build equity and earn rental income even if the economy takes a turn.

  • Taxation: You should always consider your potential tax liabilities before making any investment decisions. Unless you hold your mutual fund in a tax-advantaged account, you will be subject to capital gains tax when you sell or exchange your shares at a profit, or when you receive dividend income. When investing in real estate, your yields can be taxed after indexation, which lessens the burden by taking inflation into account. For real property, property taxes and rental income tax will be assessed, although deductions can be made.

  • Leverage: When you choose to invest in stocks, funds or act as a private lender, you’re investing your cash or retirement savings. When purchasing real estate, you get to leverage your investments, meaning you use your cash to make a down payment to purchase real estate of much higher value.

  • Control:With funds and stocks, you are often relinquishing much of your decision making to a portfolio manager. When purchasing real estate, you have full control over conducting market research, selecting a property, and choosing your financing method and debt structure. The question here might be if you prefer to take a more active or passive role towards your investments.

Summary

The merits of both investing in real estate and mutual funds are tough to ignore. If you are still feeling torn between investing in real estate or mutual funds, perhaps you may want to consider investing in real estate investment trusts (REITS), which allow investors to invest in real estate without actually purchasing physical assets. If this is of interest to you, check out this beginner’s guide to REIT investing.

As always, mind your due diligence by performing thorough research and by consulting a financial professional before making any investment decisions. Regardless of your decision, the important thing to recognize is that you are taking steps toward growing your wealth in a powerful way.

What are your favorite types of investments and why? Please feel free to share your thoughts in the comments below:

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Real Estate Investing Strategies
Real Estate Investing Strategies
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Real Estate Investing Strategies
Real Estate Investing Strategies