What is A Mutual Fund?
You can think of a mutual fund as a basket full of stocks and or bonds. The fund pools moneys from many different investors by selling shares and uses the investor’s funds to purchase stocks and bonds. Generally, a mutual fund will have a stated set of objectives and the fund will invest according to those objectives. There are funds that specialize in every imaginable financial sector from growth stock to high-yield bonds (ahem – Junk) and everything in between. Some of the most popular and financially rewarding mutual funds emulate common stock market indices such as the S&P 500. Most mutual fund shares are purchased and sold at the fund’s current net asset value (NAV). The NAV is determined by dividing the value of all the stock and bonds held fund’s basket by the number of outstanding shares.
Key factors to watch out for include “loads” and the expense ratio. Overtime, these seemingly small charges can decimate investor’s return. Some funds charge a sales commission called a “load.” This fee, which is used to compensate brokers or financial advisors, can be charged when purchasing (front-end load) or when selling (back-end load). As we will discuss later, load charging funds are rarely worth the added expense. A funds expense ratio is the sum of all administrative and operating expenses, divided by the value of the fund’s investment. It is expressed as a percentage. Expense ratios can vary widely from fund to fund but often range from 0.25 to ~2.5%. Experience has shown that paying a higher ratio is no guarantee of higher returns and funds with the lowest expense ratio are often the best performers over the long run. As we will explore later – keeping this number as low as possible is critical if we wish to maximize our future wealth.