Investing in funds can be an excellent way for beginners to get started in the stock market. Funds allow you to invest in a professionally managed portfolio of stocks, bonds, or other assets without researching and selecting each investment yourself. In this article, we’ll overview fund investing, discuss the benefits and drawbacks, and provide tips for getting started.
What is a Fund?
A fund is an investment vehicle that pools money from many investors and invests it according to a specific strategy and objective. Funds come in many varieties, including mutual funds, index funds, exchange-traded funds (ETFs), and closed-end funds.
Professional investment managers manage funds using their expertise to select investments and manage the portfolio. When you invest in a fund, you own shares representing a portion of the fund’s holdings.
Types of Funds
There are a few main types of funds to be aware of:
Mutual funds pool money from investors to purchase various assets like stocks and bonds. The most common type is an equity fund that invests primarily in stocks. Mutual funds often focus on a specific objective, like income, growth, or a particular sector.
Index funds aim to match the performance of a market index like the S&P 500. They hold the same stocks or bonds as the index they track, making them a passively managed option. Index funds typically have lower fees than actively managed mutual funds.
ETFs (Exchange-Traded Funds)
ETFs are similar to index funds but trade like stocks on exchanges. This allows for price changes throughout the day. Like mutual funds, ETFs contain a basket of assets and aim to match or track an index or sector.
With closed-end funds, the assets are not actively traded after the initial public offering, as with ETFs and mutual funds—the shares traded between investors on a stock exchange.
Benefits of Fund Investing
There are several advantages to investing in funds versus selecting individual stocks:
When you buy shares in a fund, you gain instant diversification across potentially hundreds of individual investments. This helps reduce risk compared to owning just a handful of stocks.
Fund managers and analysts research companies and markets full-time to identify opportunities. They have far more expertise than the average individual investor.
Purchasing funds is a straightforward process that provides effortless access to markets. Investors don’t have to worry about picking individual stocks.
Funds allow you to invest small amounts at a time. Many mutual funds have no minimum investment. Fund expenses are divided across all investors.
Drawbacks of Fund Investing
While funds have clear benefits, there are also some potential downsides to consider:
You don’t have control over individual investments when you invest in a fund. The fund manager makes all the decisions.
After fees are considered, an actively managed mutual fund may underperform compared to its benchmark index.
When funds sell securities in the portfolio, it can create taxable capital gains for investors. This does not apply to investments in a tax-advantaged account like an IRA.
Higher Costs Than Index Funds
Actively managed funds have higher fees than passive index funds due to the research and trading involved. This eats into long-term returns.
Getting Started with Fund Investing
If you’re ready to get started investing in funds, here are a few tips:
Open a Brokerage Account
You’ll need an account at a brokerage firm to purchase funds. Opening an account is straightforward and can be done online.
Know Your Goals
Figure out your investment goals in terms of timeline and risk tolerance. This will help determine what types of funds to invest in.
Research and Compare
Use tools like Morningstar to research and compare funds in the category you’re interested in based on past performance, fees, manager tenure, and other details.
Start with Index Funds
Index funds offer broad market exposure at a low cost. The Vanguard Total Stock Market Index Fund (VTSAX) is a great starter choice.
Make Regular Contributions
Invest consistently by setting up automatic contributions from each paycheck. Even small amounts add up over time.
Hold for the Long Term
Don’t panic and sell when the market dips. Hold quality funds focused on long-term growth for years to realize their full potential.
While fund investing has some drawbacks, like lack of control, it offers an easy and low-cost way for beginners to gain access to professional management and instant diversification. Sticking with low-cost index funds from reputable providers is a smart way to start. Investing regularly over the long term lets compounding work its magic.
Q: What is the minimum amount I need to invest in funds?
A: Many mutual funds have zero minimum investment. At Vanguard, for example, you can get started with their index funds for just $1.
Q: How often should I review and rebalance my fund portfolio?
A: Checking your portfolio once per year is sufficient in most cases. Rebalance if allocations drift more than 5-10% from your target.
Q: Are fund returns guaranteed?
A: No, funds do not guarantee performance or returns. Returns depend on the market and fund investments.
Q: Can I lose money investing in funds?
A: It’s possible to lose money investing in funds if the market declines or investments underperform. But funds help mitigate risks.
Q: What fund fees should I look out for?
A: Watch out for high expense ratios, in which funds charge annual fees to cover costs. Index funds typically have fees under 0.10%, while actively managed funds are 0.50% or more.