It is hard to believe we are already in the third month of this year! 2020 is flying by. March brings you part deux of our trilogy on investments and the focus this month is (you guessed it!) mutual funds. Who wants to talk about college basketball in March when you can talk about mutual funds?
Like our previous blog on stocks, this blog will focus more on the different types of investments you can make, and how they best serve you-growth, supplement income, emergency fund etc.-versus telling you what to invest in. A fundamental knowledge of what is out there to invest in is crucial in making sound investment decisions. Let's dive in!
First, what are mutual funds? I'm glad you asked! Mutual funds are investment pools that collect money from many investors and use that money to buy a variety of stocks, bonds and other investments. Often overseen by a money manager, mutual funds allow for small or individual investors to have access to professionally managed funds, to invest in a financial vehicle that doesn't take a lot of monitoring on their part, and allows them to diversify their portfolio even if they've only invested in one mutual fund.
Because of all the benefits of mutual funds (low maintenance on the part of the investor, and easy diversification) this is often the financial tool used by beginner (and more tenured) investors. It carries less risk than investing in individual stocks. For each mutual fund, you can read the prospectus (basically the business report provided by the managers of the fund) to see what securities (stocks, bonds, assets) the mutual fund has invested in. That allows you to determine how diverse the investments of the mutual fund are and whether or not you are comfortable investing in that fund (i.e. based on your moral convictions).
Mutual funds can serve multiple investment purposes, but are best served to achieve medium to long-term goals, i.e. investing for growth (retirement or buying a house) and income (emergency fund, regular supplements to income). Age also plays a factor in how many mutual funds are included in your portfolio. If you are further away from your retirement, you are able to deal with riskier investments and so your portfolio would probably be comprised of more individual stocks than mutual funds. The closer you are to retirement, however, the more mutual funds your investment portfolio should contain. Here are some of the types of mutual funds you might invest in:
Asset-allocation funds: This type of fund is a fund of funds. Talk about being meta. Asset-allocation funds invest in multiple mutual funds at once, so you reap the potential benefit of them all.
Balanced funds: These funds invest in both stocks and bonds to provide a balance between investing for growth and investing for income. These funds typically maintain a fixed balance between the investment classes they hold.
Equity income: These funds are largely for growth and primarily invest in stocks that pay high dividends. Equity income funds are highly volatile.
Money-market funds: This type of fund invests in short-term corporate and government debt, cash and bank deposits, investments with high liquidity. These funds are largely for investing for safety or for short-term goals, such as building up a small emergency fund or a down-payment for a car.
Sector funds: These funds invest in specific industry groups, such as tech, renewable resources, or ammunition. These funds are highly volatile because if the industry crashes, so do all your investments. If you invest in sector funds, I recommend investing across a few different ones.
Actively-managed vs. index funds: These last two categories of funds can apply to all the ones above. Just as it sounds, actively-managed funds are portfolios that are actively managed with the goal of beating market value and performance for returns. Index funds are passively managed with the aim of mirroring market value. Index funds are less likely than actively-managed funds to buy and sell investments because their aim is to maintain rather than surpass market performance. They are therefore (potentially) less volatile than actively-managed funds and better for long-term investments. Any of the above funds can be actively-managed or index funds. Checking the prospectus of any mutual fund you are thinking of investing in can let you know which one it is.
Mutual funds are easier to invest in that individual stocks; however, you should still do your due diligence before investing in them. Next month, we will wrap up our three-part investment series with information on the fees associated with mutual funds, something that should also play a factor in your decision whether or not to invest in a particular fund.
Maybe after reading this blog post, you'll be inspired to make a March madness bracket of the best mutual fund match ups! The ones that win are the ones you invest in. The only one with the power to determine that is you. Happy investing!