Understanding The Basics of Mutual Funds
It is best referred to as a money pool. A mutual fund company has investors that buy shares and all of its investors’ money is gathered and then spread out in many smaller investments.
This is basically instant diversification. While an average investor can not afford to invest in more than a handful of stocks on their own, through a small investment in a mutual fund their relatively small amount of money is able to be spread out amongst hundreds of stocks.
By spreading out the money in all sorts of different investments the mutual fund has its hand in a variety of businesses and industries around the world. This means that even if one industry fails one year the other ones should pick up the slack.
This, of course, leads to the big misconception about mutual funds which is that they are guaranteed money. While they are more secure than most investments there is definitely no guarantee. Not only can mutual funds lose money year to year but when they earn money it is by no means certain to be a large amount of money.
Further more, because of the vast diversity of their investments, the returns a mutual fund earned one year is not really an indication that it is the right mutual fund for you to invest in. Anything can happen in the second year.
That said when choosing a mutual fund it is important to look at their history. It can tell you a lot about the fund and how they do business and, basically, if they seem to be making the right decisions with everyone’s money.
A strong downside to mutual funds though is that there are a lot of ongoing costs associated with them. Unlike investing through the government there are heavy taxes and fees virtually every step of the way.
First and foremost the mutual fund company will be taking a cut of the funds profits; that’s just a given. But also there is the ongoing cost of buying and selling stocks. Not only is the investor there to share in the earnings and losses of the overall fund, but they are responsible for paying their share of those fees the fund has to endure. Lastly there is often a charge to withdraw from the fund.
That last note though is also one of a mutual fund’s perks. Unlike some other forms of group investing, typically government connected ones, a mutual fund is relatively liquid. An investor can cash out virtually any time they wish.
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