How to Understand Mutual Funds

Have you ever wished you could have a professional put together a diversified stock portfolio for you? Once you understand them, that's exactly what mutual funds allow you to do. Mutual funds are ideal for beginning investors.

Instructions

Difficulty: Moderately Easy

How to Understand Mutual Funds

1. Understand that a mutual fund consists of a group of stocks called the mutual fund holdings.
2. Understand that investing in a mutual fund means you're pooling your money. Your contribution, along with those of the other people who have also invested in the fund, will be used to buy stocks in a range of companies.
3. Realize that you don't choose the stocks your fund will invest in—these stocks are purchased by professional mutual fund managers. These managers also decide when to sell any holdings. The success of a mutual fund depends on how well the fund manager can understand the market and pick profitable stocks to include in the fund.
4. Know that mutual funds fall into one of 48 distinct categories based on the types of stocks that are included in each fund. For example, mid-growth, Pacific Asia, and emerging markets are all separate categories of funds.
5. Choose between "load" and "no-load" mutual funds. "Loads" represent the commission the broker receives. By opting for no-load funds, you can avoid paying these extra fees.
6. Check any potential investment's Morningstar rankings. The rankings range from one to five stars. Five stars indicate top-performing funds that are in the top 10 percent of their class.
7. Understand how the price of a mutual fund rises or falls. Price fluctuations are based on the performance of the stocks within the fund. This price represents the average stock price of the holdings at the close of the business day.
8. Pay attention to the stock market. Mutual funds can pay regular dividends to their holders, based on the amount of dividends earned from each stock.

Tips & Warnings

• By selecting to automatically reinvest the dividends you earn, your investment can grow more quickly.
• Operating expense ratios, which are deducted from your earnings to pay the salaries of the fund managers as well as advertising and additional operating costs, can cut into your profits.
• It's important to understand that certain mutual funds charge redemption fees if you sell your shares before a predetermined amount of time.