Previously we discussed stocks, bonds, and cash as investment vehicles. I mentioned that, unless you have specialized knowledge in the financial industry and want to spend significant time conducting research on individual stocks and bonds, mutual funds are probably your best way to invest.
Mutual funds give you professional money management and allow for diversification even if you only have a little bit of money to start investing with. Most people who have company sponsored retirement plans like 401Ks, 403bs, etc. are invested in mutual funds and are somewhat familiar with them, but some may not be so I will discuss the different types of funds available.
In very simply terms, a mutual fund is simply a pool of money that is invested in a portfolio of securities (aka stocks, bonds, cash, or other investments). The mutual fund has a portfolio manager (or sometimes several) who are investment professionals and they make decisions on which securities will be purchased by the fund based on the particular fund's objectives.
There are literally thousands of mutual funds out there to choose from and sometimes it can be a little overwhelming when trying to determine which ones to choose. I will spend quite a bit of time in following segments discussing that, but generally funds are categorized and there are many categories and even sub categories. For example a stock fund may specialize in large cap growth stocks or it may specialize in high yield bonds, etc. We will get into these categories deeper in later segments. Some even get as specific as investing only in certain segments of industry.
One key thing to think about when looking at mutual funds is fees. There are two basic types of fees involved in a mutual fund from a consumer standpoint. The first is commonly called a "load". This is a sales charge from which the person or company who sold you the fund is paid a commission and the rest usually goes to marketing, etc … When that sales charge is assessed is usually determined by which class of shares you purchase.
There are several types of shares, but the most common are A, B, and C class shares. The sales charge on A shares is known as a "front end" load, meaning that you pay the sales charge up front. It's usually a percentage of your purchase that can sometimes be as high as 5%. Charges for B class shares are known as "back end" loads. If you pull the shares out within a specified period of time you get hit with a deferred sales charge which is often prorated depending on how long you leave them in. Some companies offer C class shares which have an annual fee based on a small percentage (eg 1%) of the assets.
There are also "No Load" funds which do not charge these sales charges per se, but that does not mean that you get a free lunch. With these you will pay management fees in some form or another.
The fees that a mutual fund can charge are regulated by the Securities and Exchange Commission and are covered in the fund's prospectus, usually somewhere in the first few pages. You can hit the SEC's website to get the most current information on these fees.
A quick word about the prospectus – it is required by law that your broker or the company you buy the funds from provides you with a prospectus when purchasing any mutual fund. In addition to outlining fees and sales charges, the prospectus is a wealth of information regarding the fund's objectives, their investment guidelines, performance information, etc. It's often very dry reading, but I highly recommend that you review it before making a purchase. If you are using a financial planner or a broker part of the services they should provide is to go over some of the more important parts of what's in the prospectus. If they are not willing to do that in a way that you can understand I'd recommend that you look for another broker!