Mutual funds are investing vehicles that buy a very wide range of individual securities, like stocks and bonds. Buying one share of a mutual fund instantly diversifies your holdings, and this easy diversification makes them a favorite of both financial advisors and regular investors. Here’s what you need to know to start buying mutual funds.
1. Open an Investment Account
You buy mutual funds using an investment account. You might already do this through your workplace 401(k), but you can also do so through an online broker or have a financial advisor work with you to help set up an account.
When considering different investment accounts, pick the right one for your goals to buy mutual funds:
- Expenses Before Retirement or Long-Term Wealth: A taxable investment account will let you save for any goal, trade stocks or build long-term financial security. Notably, taxable investment accounts don’t come with any restrictions about when you can or can’t make withdrawals. As the name implies, though, you’ll owe taxes on any investment gains you make when you sell a security or any dividend payments you receive each year.
- Retirement: Individual retirement accounts, more popularly known as IRAs, provide certain tax incentives when you use them to save for retirement. You can opt for a traditional IRA or Roth IRA, depending on whether you want your tax break now or in retirement. If you’re a small business owner or self-employed, you may also look for SEP IRAs, SIMPLE IRAs and Solo 401(k)s at potential brokerages. These retirement accounts offer the same tax benefits as IRAs with considerably higher contribution limits.
- A Child’s Future: If you want to give your child a head start through investing, check to see if prospective brokerages offer custodial accounts. With a custodial account, you invest on a child’s behalf, and when they reach the age of majority (usually 18 to 25, depending on the state you live in), they receive control of the account. Notably, funds in custodial accounts can be used for any expense that benefits a child before that time.
- A Child’s Education: If your goal is to help your child pay for college, you may want a 529 account. 529s offer tax-free growth of investments as long as funds are used for educational expenses. You may even be able to deduct contributions from your state taxes, depending on where you live. Funds in 529 accounts can be used for higher education expenses, primary and secondary school tuition, and fees associated with trade schools.
How to Choose a Brokerage
When deciding which broker to buy mutual funds, you should think about your own needs and preferences, including:
- Type of Account You Want. While major brokerages offer most, if not all, types of investment accounts, you want to be sure your brokerage of choice has the account type you need. For example, you might not be able to open a 529 account with some brokerages, so if saving for a child’s education in one is important to you, locate a brokerage with this offering.
- Fees. Trading fees are largely a thing of the past, but depending on your brokerage, you may have to pay a maintenance fee or a regular management fee. Review each broker’s listed fees, commonly called the fee schedule, so you’re aware of what you’re getting into and can opt for a broker with the lowest or no costs.
- Customer Service. Think about how much help you’ll need to navigate buying mutual funds. Will you want phone or in-person contact or is online chat enough? Review the Forbes Advisor Best Online Brokers For Beginners to see our top choices for help resources.
- Additional Services. Depending on the brokerage, you might also get access to other services, like financial planning or portfolio management. Figure out what perks you’re looking for so you can be sure your broker has them.
2. Decide on Your Mutual Fund investment Strategy
After you’ve opened your account, it’s time to think about investment strategies. You’ll want to be clear on what percentage of your balance you invest in different mutual funds, like stock funds vs. bond funds. This breakdown is called your asset allocation, and chances are it’ll change over time as you move closer to your financial goals.
Your timeline is likely to influence your mutual fund asset allocation. Here’s how that might work for retirement, per investment management firm T. Rowe Price:
- 20s & 30s: 90% to 100% stocks, zero to 10% bonds
- 40s: 80% to 100% stocks, 0 to 20% bonds
- 50s: 65% to 85% stocks, 15% to 35% bonds
- 60s: 45% to 65% stocks, 30% to 50% bonds, 0 to 10% cash/cash-equivalents
- 70+: 30% to 50% stocks, 40% to 60% bonds, 0 to 20% cash/cash-equivalents
3. Research Mutual Funds
Research is vital when deciding which mutual funds to invest in. First, you’ll want to determine which type of mutual fund you’ll be investing in: actively managed funds or passively managed funds.
Actively managed funds are mutual funds managed by investment professionals who try to provide positive returns, regardless of the market’s performance, by frequently trading the fund’s holdings. Passively managed funds, on the other hand, generally aim to match the performance of a particular stock index, like the S&P 500. The research and labor they require makes actively managed funds slightly more costly to invest in than passively managed funds, whose holdings don’t change that often.
While you might expect actively managed funds to perform better than passively managed funds, this isn’t often the case over the long term. More often than not, passively managed index funds provide higher returns and lower costs than their actively managed counterparts. That’s why experts generally recommend investors choose low-cost index funds to reach their investment goals.
When you’re ready to start researching particular funds, you can turn to the educational resources offered by your brokerage or those available on third-party sites, like Morningstar. You’ll want to look for fees, such as expense ratios and load fees, which are charged when you buy or sell shares of your mutual fund.
Keep an eye out for investment minimums, too. Mutual funds generally require you to invest at least a certain amount when you first buy into a fund. After that, you can invest smaller amounts, even for incomplete, fractional shares. Be sure to write down the identification code, or ticker symbol, for each mutual fund you’ll want to purchase.
4. Buy Mutual Funds
Once you’ve identified the best mutual funds for your portfolio, you’re ready to buy. You can search for the mutual fund ticker symbol on your brokerage website and indicate how many shares you want to purchase.
It’s important to note, though, that mutual fund purchases work a little differently than ETF or stock sales. All mutual funds are bought and sold at one point in the day, once trading has finished. This means your purchase ticket may not be filled immediately.
If you’re investing for the long term, this distinction probably isn’t a huge deal because you aren’t trying to time a particular market price to turn around and make a quick sale. Instead, you’re working to get your money into the market for years- or decades-long growth. When looking at investments from that perspective, the exact price you pay on a day-to-day basis is less important as the mutual fund is likely to increase from any current prices over time.
5. Set Up a Purchase Plan
To reach your financial goals, you’ll most likely need to buy mutual fund shares over the course of months or years. That’s why it’s important to think through how you’ll plan your mutual fund purchases.
You may want to invest a percentage of each paycheck, or you may opt for a set dollar value weekly or monthly. Whichever the case, this kind of regularly investing comes with a swath of benefits, the largest of which is probably dollar-cost averaging.
With dollar-cost averaging, you routinely buy the same dollar amount of mutual funds, regardless of how the market’s performing. This way, you end up buying fewer shares when the market is up and more when it’s down. Over time, this may result in you paying a lower cost per mutual fund share.
You’ll also want to determine when you’ll check in on your mutual funds’ performance. Most experts suggest looking in once every six to 12 months to make sure your asset allocation is still on track to meet your goals. If it’s drifted from your desired percentages, you may choose to buy or sell certain investments to get you back in good standing. This keeps you from taking on a more aggressive or conservative portfolio than you intend, which can affect your future returns.
6. Decide on Your Exit Strategy
Great investors carefully plan their exit strategy. As you start buying mutual funds, you should already understand when and why you’ll be selling them in the future to minimize any tax consequences.
For taxable investment accounts, this means strategizing ways to diminish capital gains taxes, such as by holding onto investments for at least a year to benefit from a lower tax rate. For tax-advantaged retirement accounts, you’ll want to look for maneuvers that let you keep down the amount you may owe in income taxes.
Talk with a financial advisor or tax professional to figure out how to best handle your investment taxes. And keep in mind that you may owe taxes before you cash out any mutual fund shares in taxable investment accounts. The frequent trading that occurs in actively managed mutual funds may result in income gains that you don’t expect.
Mutual Fund FAQs
Mutual funds are a type of investment that contain many other investments, including stocks and bonds. Mutual funds are favored by many investors because they allow you to purchase exposure to hundreds of securities with only one mutual fund share.
How Is a Mutual Fund Different from a Stock?
Mutual funds may contain shares of stocks but are not stocks themselves. Instead, a single share of a mutual fund may grant you indirect access to the shares of hundreds—or thousands—of companies. This provides diversification, which decreases the risk that you lose money because of one poor performing stock or investment.
Do Mutual Funds Pay Dividends?
Yes, some mutual funds pay dividends. This depends entirely on whether the stocks they contain pay dividends, though. If you’re interested in earning income from your mutual funds, consider those that contain dividend aristocrats, companies that have consistently raised their dividends over years, or funds that hold bonds and fixed-income investments.
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