Mutual Fund Investing 101: How You Make Money
How do you make money investing in mutual funds? There are basically two ways to make money and two ways to lose money by investing in mutual funds. Let’s get down to the basics.
There are thousands of funds to choose from and the vast majority of them will fall into one of four categories based on where you invest your money (your money). They are called stocks (stocks), bonds, money market, and balanced funds. In all of the above, you open an account, invest money and this buys you shares. You earn money by investing based on the number of shares you own. The same is true if you lose money investing.
Let’s start with the most popular and riskiest category called EQUITY FUNDS, which invest money in stocks, which are also called “stocks.” Why invest money here? The primary objective is growth, with dividend income as a secondary objective. You make money investing here when the share price rises and with dividends. You lose money when the price of stocks goes down. Dividends come from the stocks in the fund’s portfolio and are transferred to you. They (like all dividends) are yours. The main attraction of equity funds: the potential for high returns.
BOND FUNDS have one main objective: higher income in the form of dividends. They are also called INCOME FUNDS and are generally safer than the stock variety. You invest money here to earn higher dividends than you can get elsewhere. Dividends come from interest earned on the fund’s bond portfolio. You can also make money by investing when the price of stocks rises; and lose money when the stock price falls. Typically, there is considerably less price fluctuation than what you will find in the stock category.
BALANCED FUNDS are a happy medium between the previous two, because they invest money in both stocks and bonds. So you make money from both rising stock prices and dividends, and you lose money investing when stock prices drop. Here you have moderate risk.
MONEY MARKET FUNDS are the safe alternative and you earn money investing in them in only one way: dividends. They invest money and earn interest on high-quality short-term notes (in the money market). This interest is transmitted to you in the form of dividends. The share price is set at $ 1 and does not fluctuate. Investors rarely lose money investing here.
Most people invest money in mutual funds as a long-term investment. So, in most cases, they simply allow the fund company to reinvest all dividends (and other distributions) to buy more shares. Distributions (like capital gains from the sale of stocks) are a bit technical. Don’t worry, if you have them to come, you will get your share. And you will also receive periodic statements showing activity on your account.
At the beginning we said that there are basically two ways to make money and two ways to lose money by investing in mutual funds. What is the second way to lose money? Let me give you an example, and as a former financial planner, I’ve seen this happen over and over again. Joe Blow decided to invest money in mutual funds through a “financial planner” (not me). He put $ 20,000 into a stock fund and about a year later he looked at his last statement and it showed a total value of $ 19,000.
The stock market in that year showed a modest gain. How did you lose money investing? Answer: $ 1000 came out of the top to pay the sales charges called “charges.” Approximately $ 300 went to annual fund expenditures and another $ 300 to additional fees. Joe claims he knew nothing about these charges and fees.
You don’t have to pay a lot of money when you invest money in mutual funds. If Joe had opted for NO CHARGED funds, he could have invested for a total cost of about $ 200 a year, for expenses. You can make money by investing in mutual funds as a long-term investment. Just don’t work against it by losing money due to high fees and charges.