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The Investor's Guide To Mutual Funds.

Article By : Patrick Mansfield | U.S. Consumer Finance
Guide To Buying Mutual Funds

Investing in mutual funds has been an important tool for many Americans to meet financial goals, such as funding their retirement accounts. Professional management and diversification are two major benefits of mutual funds. However, there are certain risks to these funds, which is par for the course for any investment. Investors should be aware that taxes and fees cut into a mutual fund's return. The negative and positive aspects of mutual fund investing must be weighed, and investors need to know how to select products that meet their risk tolerance and financial objectives. 

Important Points

No government agency, including the FDIC, insures or guarantees mutual funds. This rule also applies to funds that are purchased via a bank, even if the funds contain the bank's name. Investors should keep in mind that it is possible to lose money on mutual funds. 

Although a fund's prior performance does not correlate with its future performance, it can help investors determine the fund's long-term volatility. 

Mutual Funds and Their Operations Defined

Similar to an Exchange Traded Fund, or ETF, companies gather money from multiple investors, and they funnel the money into bonds, stocks, and other assets or securities to form a mutual fund. The fund's combined holdings are called a portfolio. Every share in the portfolio depicts each investor's proportionate ownership in the holdings and the holdings' income. 

There are several characteristics that set apart mutual funds, which are: 
  • Fund shares are purchased from the fund or the fund's broker as opposed to secondary market investors such as those who participate in the Nasdaq Stock Market or New York Stock Exchange.
  • Investors can sell shares to the fund from which they came, making mutual funds “redeemable.” Mutual funds sell and create fresh shares for new investors; therefore, funds sell shares continuously unless they grow too big.

SEC-registered “investment advisers” are separate entities who manage a mutual fund's investment portfolio.

Pros and Cons Of Mutual Funds

All investments have positive and negative points. Of course, certain aspects that hold importance with one investor may not carry the same weight with a different investor. The investor's circumstances determine whether any given feature is advantageous. Some investors find mutual funds to be favorable investments because they offer the following four attributes. 

Affordability: A few mutual funds set comparably low initial purchase or monthly purchase prices to attract those who do not have much money to invest. Some mutual funds offer low prices on both purchases. 

Diversification: This investment strategy dictates investors spread their investments among a wide array of sectors and companies to reduce losses if a sector or company fails. In some cases, investors can better diversify their investments by choosing to own mutual funds instead of individual bonds and stocks. 

Liquidity: Investors can quickly redeem their mutual fund shares at the present NAV. 

Professional Management: All the securities purchased by a mutual fund are overseen by a professional money manager who researches, chooses and monitors the securities' performance.
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