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Demystifying Mutual Funds

by Jerri L. Ledford

Mutual funds are still a mystery to many people though they seem to have gotten easier over the years. Something about investing in a "portfolio" type investment just throws people for a loop. It does me, I know.

The truth is, they aren't really all that hard to understand. There are several key points about mutual funds that will help to take they mystery out of them.

What is a mutual fund?
First, understand that a mutual fund is a portfolio for which an investment company pools money from a number of investors. Then the company purchases securities on the investors' behalf. This type of investment offers a variety of benefits:

Professional management by a highly skilled individual who manages the fund according to predefined objectives.

The opportunity to invest in more companies; an opportunity that few investors can afford without the benefits of a mutual fund.

The freedom to sell on any given business day.

Convenience. Shares may be bought or sold over the phone or by mail and they can be easily moved from one fund to another if your investment needs change.

Mutual funds make money in one of two ways. They either create returns in the form of interest or dividends, or they create capital returns in the form of appreciation.

Types of Mutual Funds
There are more than 7,000 different mutual funds available. Sounds overwhelming, doesn't it? Fortunately, most of those funds fall into one of four categories:

Balanced Funds — These are funds that invest in stocks, bonds, and sometimes cash reserves.

Stock Funds — These funds invest in common stocks.

Bond Funds — These funds invest in long-term government or corporate "I owe yous."

Money Market Funds — These funds invest in cash reserves or short term "I owe yous" issued by governments, corporations, banks or other financial institutions.

The type of mutual fund that will best suit your needs will depend on your investment situation. Some funds are high risk but offer great short-term results while others are low-risk but offer better long-term results. Research the fund you wish to invest in, and match it closely to your investment needs. And as always, when in doubt, consult a professional.

Loads and Other Fees
Common terms heard in connection with mutual funds are "load" and "no-load." A load fund is one that has a sales charge. A no-load fund has no sales charge.

That would make it seem that investing in a no-load fund is the only logical choice. In fact, why even have a load fund? The answer isn't quite as simple as that.

With load funds, there is a charge of up to about 9 percent of the total sum invested that can be leveraged either when you invest or when you sell your investment. Loads leveraged up front are generally higher than those leveraged on selling.

Another type of fee that will apply to all mutual funds, load or no-load, is to cover operating expenses. This covers investment advisory services, legal services, accounting services, postage and telephone expenses and some marketing and distribution costs. This fee, which is called an expense ratio and is expressed as a percentage, can vary from just under 1 percent to as much as 10 percent.

Research the fees associated with the mutual funds you are considering. No-load funds seem like a better deal, but upon close examination, you may find the fees are considerably higher. Fees eat away at your returns, so the lower the costs, the better your earnings.

Getting Started
So, do you understand mutual funds better now? Are you ready to get started investing in them? Before you do, define what your earning objectives are, and then what your personal financial needs are.

One hurdle that prevents many people from investing in mutual funds in their relatively high start up costs. Most funds require between $1,000 and $2,500 initial investment. Lucky for us moms, there are a number of companies that offer mutual funds for considerably less.

Warburg Pincus SaveMyMoney Funds — This company offers funds that can be started with an initial $250 investment. Then they will deduct $50 a month from your checking account to build the fund. It doesn't get much easier, or more painless than that.

Strong Funds — This company offers a variety of mutual funds which you can start with as little as $50 as long as you agree to the $50 automatic debit from your checking account to grow the fund. Strong also offers reasonable fees.

Invesco.com — Invesco.com offers many of the same type services that Strong Funds offer, but for the more technically savvy, they are an Internet company, which means you can do your investing online.

Mutual funds are a great choice for long-term growth or short-term income. What's important is that you take the time to learn about them before you begin investing. When it comes to your money, the only choice you have is to make decisions based on knowledge. And everyone knows that knowledge is power. Knowledge also takes the mystery out investing.

Jerri Ledford is a freelance writer and small business expert for the Visa/First USA Bank eBizCenter. She is also an instructor for the Writer's Village University (http://www.writersvillage.com) and the Co-Owner/Co-Moderator of the Momwriters Web site (http://www.momwriters.com) and LISTSERV. You can e-mail her at JerriLedford@cs.com.