Mutual fund investment can be an excellent way to diversify your portfolio, but before diving in there are a few key considerations you should keep in mind.
Investors should understand all fees, sales charges and expenses that could compromise returns over time. Furthermore, it is wise to assess a fund manager's track record as well as understand the advantages of dollar cost averaging or automatic investing plans.
Types
There is an abundance of mutual funds available, so find one that best meets your investing goals and risk tolerance. In addition, make sure to research how fees and costs impact its net asset value.
Mutual funds offer diversification and professional portfolio management at a reasonable cost, making them accessible even to individuals with relatively modest investments. Mutual funds also help provide exposure to asset classes, regions or market niches which would otherwise remain unavailable otherwise.
Actively managed mutual funds rely on teams of investment managers to attempt to outstrip the market, potentially increasing costs over passively managed options like index funds.
Mutual funds often charge sales charges known as loads to compensate the broker or financial advisor who sold them to you (this differs from transaction fees that apply when trading stocks and securities). Learn about different types of load charges here.
Taxes
Mutual funds produce income in the form of dividends and capital gains. Dividends are subject to your income tax rate while capital gains held for more than three years may qualify for reduced long-term capital gain rates (LTCGs).
Maintaining an accurate account of your taxable gains and losses when selling shares of a mutual fund is vitally important. Your mutual fund company should send out an annual statement detailing your transactions, detailing an "adjusted cost basis" for each share you own - this figure determines any gains or losses which must be reported as income tax due. Investing through tax-advantaged retirement accounts like an IRA or Roth IRA exempts these gains, interest, and dividends from federal income tax altogether.
Fees
Online purchasing and selling of mutual funds is convenient, yet you should remain vigilant of fees and charges associated with each trade. Most brokerage firms will charge a transaction fee/commission per trade; however, some options exist where no such charge applies.
Funds charge investors an annual maintenance fee to provide professional management services; this fee is known as the expense ratio.
Mutual funds make money when they earn interest and dividends from the securities they invest in, then distribute these earnings to shareholders. Furthermore, capital gains may be realized when selling those same underlying securities at higher than what was initially paid for them; redemption fees when shares are sold, as well as purchase, exchange, and account fees can also be charged by funds.
Distributions
Distributions from mutual funds provide income or capital gains proportional to your number of shares owned, and this income may be taxed depending on its composition - tax-exempt interest versus non-dividend dividends - as well as your cost basis of shares owned.
When selling shares, your average cost basis must be used to calculate any gains or losses on their sale. This applies even if you sold or exchanged them for other shares within the same mutual fund - provided you identified and specified which specific share was sold or transferred.
Mutual fund investment comes in various forms, from workplace retirement plans and individual retirement accounts (IRAs) to discount brokerage accounts and online brokers. An experienced financial advisor can assist in choosing appropriate mutual funds that fit with your goals and needs.
Regulation
Purchase mutual funds using a workplace retirement plan, individual retirement account (IRA), or brokerage account is straightforward and can help you realize your financial and investment goals easily. Before investing, however, it's essential that you assess both your finances and goals so as to establish how much to put away in mutual funds and which types of portfolio to create.
When selecting a fund, it is also essential to take its past performance and track record into account. A proven investment track record gives investors confidence that the fund will fulfill your long-term goals. Furthermore, make sure to review fees such as front-end loads and management fees to minimize fees; those paying too much could reduce potential returns, so look for funds with low expense ratios; as an alternative, consider using discount brokerages like E*TRADE or Betterment which charge lower transaction and maintenance fees than traditional brokers.
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