Investing Basics: Getting Started with Mutual Funds

Let’s Start with the Basics

A mutual fund is usually a combination of stocks, bonds and/or cash that is professionally overseen by a fund manager. For example, instead of researching and choosing many individual stocks yourself, you can invest in one or more mutual funds to be diversified into many underlying investments. Remember, mutual funds are intended to be long-term investments, and are not meant to be traded on a frequent basis. We will explain some of the most basic investing terms below.

The Benefits of Mutual Funds

There can be many advantages to investing in mutual funds – here are some of the main benefits you can gain:

• Professional Management: mutual funds are professionally managed by fund managers who have experience investing in financial markets.
• Diversification: mutual funds provide diversification – i.e., not putting all your eggs in one basket. When you invest in mutual funds, you increase the number of companies you are investing in. Diversification can help protect your money from ups and downs in the market, because when one investment performs poorly, another might be doing better.
• Reduced Costs: costs are reduced because the funds’ investment advisers purchase the stocks and bonds that make up a mutual fund and expenses are spread among a large group of investors.

What’s the Difference Between Stocks, Bonds and Cash?

Mutual funds are made up of mostly stocks, bonds, and/or cash and cash equivalents.

A stock is basically a tiny piece of ownership in a company. When the company does well, the stock does well, and the stock’s value will usually rise. On the other hand, when a company’s performance falters, its stock usually does too, and the value of the stock may drop. Stocks are also known as “equities” or “shares,” and are generally a riskier investment than bonds.

A bond is a fixed-income investment in which an investor loans money to a company or government entity. It works like this: an investor (someone like you) buys the bond at a certain price (the principal) from an issuing company or government (someone like the U.S. Government). In exchange, the issuer agrees to pay interest and return the principal back to the bond holder, after a certain amount of time.

Cash and cash equivalents are either cash or assets that can be converted to cash very quickly, usually in three months or less. Bank accounts and treasury bills are examples of cash equivalents. Cash equivalents are very low-risk investments.

Finding Your Risk vs. Reward Balance

Every investment has the potential to make – or lose – money. These two factors are called risk (the potential for loss) and reward (the potential for gain). Generally speaking, risk vs. reward is a trade-off; the more risky the investment, the greater the potential to earn (or lose) money.

Cash deposited in an FDIC insured bank account is generally seen as one of the least risky investments. Putting all of your money into a single stock, on the other hand, is usually a much riskier investment, since stocks can rise and fall in value quickly and dramatically.

What Type of Mutual Funds Should I Consider?

When investing in mutual funds, consider how much risk you are willing to take on in pursuit of returns.

• Lower risk mutual funds give you a combination of preservation of capital and some current income while reducing risk.
• Moderate risk funds give you a combination of potential long-term growth, preservation of capital, and current income if you are willing to tolerate some risk to achieve these goals more rapidly.
• Higher risk funds are designed to help you achieve long-term capital growth. These funds can fluctuate more sometimes dramatically, over the short term.
  
  

Can I Lose Money?

Yes. Mutual funds are invested in the stock and bond markets and involve varying degrees of risk depending on the funds you select. However, there are a few simple ways you can help reduce the risk:

• Build a Balanced Portfolio: a balanced portfolio with investments in a variety of major investment classes (stocks, bonds, and cash) can help keep you diversified. When one type is struggling, the others may be doing better.
• Keep Your Investments In Line with Your Goals: make sure your investments match your financial goals. In other words, keep money you may need for the short-term out of more aggressive investments, reserving those aggressive funds for the money you intend to grow over the long-term.

Now that you’ve been presented with the basics, you can use what you have learned to find a mutual fund that is right for you.

Please note: investors should consider carefully information contained in the mutual fund’s prospectus, including investment objectives, risks, charges and expenses. Please read the mutual fund’s prospectus carefully before investing.