Investing in mutual funds is probably one of the best ways of investing in the stock market. Buying and selling mutual funds is easy, they come in virtually any size you can imagine, and they are diversified. However, you should understand several things before investing in them. The following are some five considerations before you start buying and selling mutual funds.
1. Most Mutual Funds Have Loads
The load is a fee typically paid to your advisor or broker for selling the fund on your behalf. A load can be charged in a variety of ways: front, back, level, and no load.
A front load is charged upfront, and it usually ranges between 3 – 6%. The upfront fee comes from your investment, and most of it goes to your broker.
A back load is not charged up front but is assessed if you take your money out of the fund before a certain period usually 4 to 7 years.
A level loaded fund normally carries a 1% additional internal expense that is paid to your broker. Most level loaded funds will also attract a 1% fee for liquidating the fund within the first year.
Both level-loaded and back-loaded funds have a higher internal expense ratio discussed below.
The no-load fund does not carry a fee. However, remember that the reason the no-load fund is cheaper is that you have nobody to advise you, therefore nobody requires payment.
There are also cheap no-load institutional funds, but normally you will have to invest more than a million dollars with the fund family to qualify for this share class. The fee-based advisors normally use such funds for their clients.
2. All Mutual Funds Carry Internal Expenses
The expenses are simply the fees associated with running the funds. They cover legal, accounting, trading, as well as other expenses of the fund. Internal expenses can cost the investor anywhere from 0.25% to Over 2.5%. Remember that the fees come from your return. The less the internal expense, the more of the returns of the fund you will get to keep.
3. How Mutual Funds Trade
Open-end mutual funds, unlike stocks, do not trade on the market. When buying and selling mutual funds, you are simply buying and selling it from the fund company. Due to this trading method, the time at which you buy or sell the fund has no impact.
Simply put, if you buy a fund on a Tuesday at 12:30 p.m. your fund is not priced or traded at 12:30 p.m. it is priced at market close. The same thing happens when you sell a fund. Mutual funds do not trade throughout the day. They are priced and only trade at the end of the day.
4. Mutual Funds Are Not Taxed like Stocks
Mutual funds are taxed based on the way the manager of the fund trades the securities within the fund. In case the fund manager sells a stock in the portfolio today and it gains, the gain will be passed on to the shareholders. These gains may be okay for the investors that bought the fund last year when the manager first bought the stock. However, it is not very positive for the investor that has just invested in the fund, has not realized the gain, but still has to pay the tax. Mutual funds can, therefore, be quite tax inefficient.
5. Fund Managers Have To Adhere To Strict Investing Guidelines
Having the knowledge that your fund’s manager can only invest in a specific type of stock is good for helping you understand what you are invested. However, this can also hurt you significantly if the particular asset class is following a downward trend.
For instance, if you had invested in a technology fund in 1999, you most likely did relatively well into the early 2000s but after that you probably lost a significant sum. By prospectus, objective, and charter, the manager of your fund was required to invest most of the assets of the fund in technology securities. Just try to understand that it was not the fault of the manager. He was simply doing his job. His hands were tied, and the only place your fund could go was down.
The Investment Company Act of 1940 that provides rules for governing open-end mutual funds, those funds must invest at least 80% of their assets in the associated asset class.
Buying and Selling Mutual funds can be a profitable venture. However, just like any other investment vehicle it has its advantages and disadvantages. Based on the information provided in this article, you should now understand the top five things you need to understand before you invest in mutual funds. The key thing is to be aware of the pluses and minuses when investing in mutual funds and you will be a smart and hopefully profitable investor. Work with a trusted adviser such as Robert Domanko. Robert Domanko has several years of experience in the markets.
Additional Resources: http://robertdomanko.com/