Mutual Funds: Everyone's got them, but do you want them?

Mutual funds are the most common type of investments in the United States.

In fact, most households have a lot of money invested in this type of asset(~25%).

The reason is simple; people do not have the time or patience to do all the necessary research.

There are over 7,000 stocks alone, not to mention bonds and other types of investments.

And even if they did have time, trying to be an expert in every industry is impossible.

It makes more sense to rely on professionals, whose job it is to research and select good quality companies for investing.

What is a Mutual Fund?

Basically, it is a large amount of money that is pooled together, managed by an investment firm, and registered with the Securities and Exchange Commission.

Within the investment firm, day to day management of the fund falls to a registered investment advisors (RIA), more commonly known as professional money managers. They study and research different industries and select the types of investments that meet a certain set of criteria.

Shares are purchased using money from the "pool" mentioned earlier, and these shares are added to the "basket" of investments that create the "fund". The investment firm then turns around and offers investors the chance to buy and sell shares of the "basket".

Performance is only as good as the investments purchased.

Funds may also be categorized as index or actively-managed.

Typically, mutual funds are modeled around their main investments. The four major types are money market, fixed income (bonds), equity (stocks), and "hybrid". Balanced, asset allocation, target (date or risk), and lifestyle are all types of hybrid funds.

Safe Investing Tip Did you know?
Money market funds got their start in the 1970's, when interest rates were very high. Although they are popular today, chances are they would not be if they were introduced in the low interest rate environment of the early 2010's.



Types

There are 3 main types of mutual funds in the U.S.: open-ended, unit investment trust, and closed-ended.

Open Ended are the most common. These funds are open to new investors and buy/sell shares on the open market at the end of every trading day. The investment firm can "create" as many shares as needed to satisfy demand.

Close Ended funds are becoming less and less popular as the number of different types of investments grow. When the fund is created, the shares go through an initial public offering and then the fund is "closed" to new investors. If you want to sell your shares, you must sell them to another investor, rather than on the open market. This means that you may or may not get the quoted share price. If there are a lot of investors trying to get into a closed fund, then there will be a premium on your shares. If there is no demand, then you might have to sell your shares at a discount.

Unit Investment Trusts (or U.I.T.) share characteristics with open and closed ended funds. A UIT issues shares through a public offering, and the number of shares are fixed afterward (like a close-ended fund). Investors can sell their shares on the open market (like an open-ended fund).

Why Buy Mutual Funds?

Advantages

  • Potential Diversification
  • Liquidity
  • Professional investment management
  • Availability of investments that may be available only to larger investors
  • Ease of Use


Disadvantages

  • Fees
  • No opportunity to customize
  • Reduced liquidity compared to ETFs and Equities


Where to Buy Mutual Funds

You have access to any type and/or category of fund mentioned above in almost any brokerage account. But keep in mind that you may not have access to every "firms" fund. For instance, if you have a brokerage account with Fidelity, you may not be able to purchase funds from T. Rowe Price.

Here are a few of the top investment firms which offer their own funds:

  • Vanguard (Known for their low fees)
  • Fidelity (Learn more about Fidelity here)
  • PIMCO (Specializing in Fixed Income/Bond Investments)
  • Franklin Templeton (World's largest equity fund)
  • T. Rowe Price (First to charge fees based on assets under management)


Are They Right for Your Portfolio?

As I mentioned above, sometimes you don't have a choice. My 401k provider only has mutual funds, so those are the only type of investments I can use.

But if I had my choice, I would use exchange traded funds, or ETFs. An ETF exists for almost every type of mutual fund, and almost ALWAYS has a lower expense ratio.

And you can trade them any time you want, rather than having to wait for the closing price.

How to Start Buying and Selling

If you have a retirement account, you probably own them already.

But how do you know which type/category to buy?

Check out my page on diversified investment to learn how about the different types of assets you can buy.