Mutual Funds for Dummies

This publication, so insensitively named Mutual Funds for Dummies, will complete our "dummies" series in this section of the publication.  We have already covered topics such as stocks and investing, and now we are rounding out our dummies section with this dummies article on mutual funds.

We are also going to follow the same format as our prior articles of this type, and offer you just enough information to get started investing in mutual funds.

Why Mutual Funds for Dummies?

We can draw two conclusions from the fact that so many people look for simplified explanations:

• People are busy doing what they do best, and are looking to reduce the total amount of information they need to absorb.  We live in the information age, and the "dummies" approach helps to distill information down into more manageable chunks.
• Investors recognize the value of mutual funds, and want to quickly understand how to get started in this area.

We realize that some of our readership might be offended by a title like "Mutual Funds for Dummies," but we also know that some people appreciate this simplified approach to sharing information.  For those of you that are offended, we offer our apologies.  For those of you looking for simplified information on mutual funds, just keep reading.

Risk and Mutual Funds

Investing in mutual funds is fairly easy; in fact it is much easier than investing in stocks.  That's because when you purchase a mutual fund, you are really purchasing a portfolio of stocks and / or bonds, and that lowers the risk of your investment.  When you purchase an individual stock in a company, you are really taking on two kinds of risk.

• The first form of risk is associated with a single company investment. For example, the company can have operating problems and miss their earnings per share targets.  This will cause their stock price to decline.
• The second risk has to do with more macroeconomic factors.  The entire industry could suffer a downturn, or the entire stock market could enter a bear market.

Mutual funds allow you to eliminate most of the risk associated with individual stocks through the portfolio concept.  By holding more stocks or securities in a portfolio, you lower your overall negative exposure by spreading out the risk.

Mutual Fund Research

Unfortunately, even dummies need to do their research.  If there is one shortcut that should be avoided, it is not mutual fund research.  Fortunately, we have three articles that can help you to get a jump start in this area:

• Mutual Fund Ratings - this article discusses the most commonly used, and arguably the most famous, rating system for mutual funds:  The Morningstar system.
• Mutual Fund Research - this article is a good place to get a better feel for the types of mutual funds that are available to the investor.
• Mutual Fund Performance - finally, this publication discusses how you can go about determining a mutual fund's performance, and what to look out for when evaluating a mutual fund.

Mutual Fund Fees

The price of one share of a mutual fund is usually quoted in terms of NAV, or Net Asset Value.  This is a number that can be found online or in the newspaper. Investing in mutual funds is pretty easy since most brokerage houses allow you to add money through automatic withdrawals from a bank account.  This can help you build up your investment portfolio in a less painful manner.

Perhaps the most important short-term consideration to take notice of is the mutual fund's fee structure.  We've discussed this in more detail in No-Load Mutual Funds and Mutual Fund Loads.  If the mutual fund carries an upfront fee of 5%, then you are automatically starting with a fairly significant loss on your investment.  In almost all situations, no-load funds are a better investment. This is especially true in the short term.

Finally, mutual funds also charge management fees.  These fees are used to pay the trading costs and management salaries of the individuals running the fund.  Smart investors will want to make sure that the fund fees are low.  As a guide, a good mutual fund index fund will have fees in the 0.5% range, while a domestic stock fund might be around 1.20%.  Index funds are not actively traded, while domestic stock funds can be actively traded.  These two values should give you a good feel for the range of mutual fund fees that are acceptable.

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