Mutual funds provide a way for the average investor to diversify their holdings into many different types of investments chosen by professional fund managers. Professional management of this type is usually not available to smaller individual investors. Mutual funds are a popular choice for investors, with different types of funds available for different goals. A mutual fund's average return depends on the type of fund purchased and other factors.
A mutual fund that invests primarily in stocks should deliver an average return over the long term of at least 8 percent. A better managed stock fund may deliver better returns. Bond and money market funds generally deliver lower long-term returns, but they are less likely to change rapidly in the short term. Stock mutual funds can have large fluctuations in value and rate of return within a relatively short period of time.
A mutual fund's expenses reduce the rate of return. These expenses are related to managing the fund, and marketing the fund to new investors. Managing expenses include the salaries of the fund managers, and the cost to trade stocks or bonds that the fund holds. A mutual fund's expense ratio is published in the fund's prospectus. You should pay as close attention to the expense ratios of any funds that you consider purchasing as you do the historic rates of returns, but keep in mind that a more expensive fund may deliver better results.
A mutual fund must report its capital gains to its individual shareholders, and you would have to report the capital gains and dividends paid to you each year on your income tax return. Of course, you will pay taxes on these profits. Some fund managers do a better job at minimizing the tax impact of their funds by controlling certain types of trades. If you are investing in a tax advantaged retirement account, tax impact is not important as all of the gains are tax-free or tax-deferred.
Mutual funds come in either a load or no-load variety. A load is a sales commission that the fund pays to the brokers who sell the shares. Loads may either be front or back end. A front-end load fund pays a commission from the initial investment. If you invest $10,000 in a mutual fund with a 5 percent front-end load, the selling broker is paid $500 and $9,500 is invested in the fund. A back-end load pays the broker commission when you withdraw the money. A no-load fund does not have any commission at all. Any type of fund may charge a 12b-1 fee, which is generally used for marketing the fund. Pay careful attention to sales fees as they can significantly affect returns.
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