Mutual Fund Basics: The Guide To Getting Started With Mutual Funds

In the last article I talked about 5 core investment tips for you to use to ensure a smooth retirement.  In this article I’m going to talk more about the vehicle you will use to make that journey towards a successful retirement.

In this article I am going to cover the basics of mutual funds by giving you the ins and outs of how they work and how you could use them to your advantage.

What Is A Mutual Fund

A mutual fund is a pool of money that contributed by investor that is managed by a fund manager who invest the money for the sole purpose of earning a profit.  Each fund will have one or multiple fund managers who will oversee each fund.

On top of that each fund will have an objective.  For example, The Growth Fund of America by American Funds, has objective is to provide growth capital by investing in whatever the best growth opportunities might be.

Finally each and ever mutual fund will include a prospectus which a document you should receive before you buy any mutual fund.  The prospectus contains all the information about the funds fees and expenses, past performance, investment objectives and much much more.

What Are The Fees

So now that I’ve cut through some of the dry stuff about mutual funds I believe it’s important I cover one area about mutual funds that a lot of people don’t know much about that could affect your wallet the most and that is the fees.

Most people who buy a mutual fund have no idea what kind of fees they are paying in fact I use to think the were all the same but I learned real fast when I was a financial adviser that it was not this way.

The first fee most mutual funds will charge  is what it called a sales load, also known as a sales charge this fee is charged for the initial sale of the mutual fund.  However not all companies will charge the same fee for example Transamerica Funds charges 4.75% and American Funds will charge 5.75%.

However most people don’t know what they are being charged here in fact some companies like Fidelity and Vanguard will have a 0% sales charge, and have very low fee structures to help investors save more.

Although when it comes to paying mutual fund sales charges you may not have to pay the full sales charge if you have enough money to hit what it known as a break point.  A break point is reduction in the sales charge for having more money in the account.

For example if you would invest $60,000 into a mutual fund and they would offer a break point at $50,000 you would get a sale charge of say 4.75% instead of 5.75%.  Now you might be wondering how do I get a break point?  By law all financial representatives are suppose to give you the break point if you qualify for it.

However, I should also mention that break points are only give to those that invest in class A shares.  Now you might be wondering is a share class?  A share class is nothing more than a method used to determine how the sales charges will be paid.

The three most commonly used share classes are A, B, and C.  An A share will take the full initial  sales charge up front, a B share will deffer the payment over period time instead of taking it all at once and a C share will charge a level fee.

However for the most part I suggest you stick with the A share class since this will be the easiest to qualify for.  With B and C share classes it’s often times harder to qualify for and you will usually have to give a good reason why you want to do this.

Lastly, as far as the expenses go mutual funds you will also be charged for what is known as annual expenses on a fund.  For example companies like Transamerica Funds will charge as high as 1.19% and companies like American Funds and Fidelity will only charge 0.76% and Vanguard will charge on average as low as 0.23%

Knowing the fees that are charged in a mutual fund can make a big difference.  Here is an example of what it could cost you from one company to another.  Lets say you invested $30,000 with American funds.  First off they would charge an up front fee of 5.75% and an annual fee of 0.76%.  This will equate to $1953 in your first year of expenses and $228 thereafter.

On the other hand if you chose Vanguard the only fee you would pay is an annual fee of 0.23%.  This would cost you $69 a year in fees.  This is the difference in fees by picking the right company to handle your investments and is one the mutual funds basics that everyone should be aware of.

How To Build A Portfolio

Finally, when it comes to the basics of mutual fund investing you need to be aware of how to build a proper portfolio that will fit the needs and investment risk you are able to handle.

Every mutual fund has their own way of doing things but one of the most popular methods is to do what is known as an asset allocation.  This is a simple 7 question quiz that will help you determine your short and long term risk and help you pick an asset allocation that is right for you.

These asset allocation models will range from conservative to aggressive.  Here is an example of four different asset allocation models from Transamerica Funds.

The reason asset allocations are so nice is that they don’t contain just one fund they contain many different funds which allows you to invest your money across many different funds and cut down your risk.  If one fund doesn’t do so well others will and they can make for the loss.

Finally when getting started you will have to be aware of how much money it will cost to get started.  For example, American Funds will only need $250 to get started while Transamerica will require at least a $1000 to open an account or an ETF (Electronic Transfer of Funds) with a $100 monthly deposit.

Final Thoughts…

As a final thought before I end this article I should let you know that no mutual fund is guaranteed to earn a profit.  I’ve seen funds do great and some not so great but past performance does not guarantee future results.

So take your time and do your research and look at the fees before you invest your money.  The mutual fund basics I’ve given you here will help you get started but don’t be afraid to ask a question in the comment section below if you need some help.

Chris