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Mutual funds carry a unique set of risks and benefits in just the same way as other investments, despite marketing that may have led you to believe otherwise.
A mutual fund is an investment in securities, including bonds, stocks and other vehicles, that is funded by a pooling of money from various investors. Before you decide to invest in a mutual fund, you need to know what you`re getting and what all your options are.
Stock, Bond and Money Market
Mutual funds usually come in three distinct types. Each type has inherent drawbacks and benefits, so weigh your financial goals and risk tolerance before making a final decision.
The stock mutual fund has the potential to pull a high return but poses more risk than the other available types. With stock funds, you must consider the purpose behind the stock selection. For example, some firms bundle together stocks in a particular industry, such as medical. Others use more general selection criteria to meet a goal, such as rapid growth.
Since stocks are known to fluctuate and are fully exposed to the volatility of the market, you can lose a significant portion of your investment if the fund stocks tank or the market itself dives. Get familiar with the fund manager`s aim behind the stock selection and evaluate current stock rates and histories for those securities included in the funds.
A bond fund is often less risky than a stock fund but carries more risk and a higher gain potential than a money market vehicle. Bond funds vary dramatically in type, from 'junk bonds` issued by weakened or new companies to municipal bonds from local governments.
Junk bonds naturally carry a lot of risk but have a higher gain potential. A new company may take off unexpectedly, earning you a big return on your investment. On the other hand, if the business fails, your fund`s value will drop. Municipal bonds from a stable city will cost more but carry less risk than a bond from a city that is struggling. Since the risks and benefits vary greatly by bond type, you`ll need to consider all the angles before investing in a bond fund.
A money market mutual fund, not to be confused with a money market bank account, is normally the mutual fund type that carries the lowest risk and gain potentials. Federal regulations restrict money market funds to safe bets, such as short-term investments in high quality vehicles. While you won`t have the opportunity to gain as much as you could under a stock or bond fund, money market funds may be a good option for you if you`re testing the waters or have a low loss tolerance.
Know the Fees
Your mutual fund choice is subject to fees charged by the managing entity. Know what all the fees are associated with the funds you`re considering so you can compare rates across different providers.
You may have to pay a percentage fee upfront or when you sell. Some funds charge a management fee instead of an upfront or back end percentage. Other costs are deducted from the total investment pool itself, as found under the managing entity`s fee table in the prospectus. While you won`t pay an individual bill for those other costs, excessive fee taking from the entire pool can hurt the fund's performance.
Selecting a managing entity can be almost as difficult as deciding the fund type. Price alone shouldn`t be the deciding factor, as you need a fund that is managed well to protect your investment and earn a return. Look at feedback from Finance Community about the fund managers you`re considering and review past performance before making a decision.