Mutual funds are also frequently broken into “value” or “growth” categories. A “value” fund is one that is “cheap” right now, when compared with it’s past earnings and reasonable estimates of its current evaluation. A “growth” fund is one that is currently growing really fast and is likely to yield some profits in the very near term. A “blend” fund takes stocks from both of these categories.
The general philosophy is that growth funds can yield higher profits, but are also a little riskier.
Now that we have those two sets of terms defined we can look at our first risk vs reward chart.
The idea here is that a “Small Cap, Growth Fund” tends to take on more volatile stocks, which can mean greater profits but definitely means greater risk. Conversely, “Large Cap, Value Funds” are probably much more stable in the long-term. Again, in theory.
On the surface, a graph like the one above seems like it must be over-simplifing the entire economy. But since this is frequently how mutual funds are designed, this graph has real value. It lets you know how funds are run.
Mutual Funds can be a solid way to invest your money. But the companies that run mutual funds are for-profit businesses. Either up-front, or over time, mutual funds charge you money. And they can take a lot of your profits.
Mutual funds can charge you fees in lots of different ways, but two of the most common are:
A good rule-of-thumb is:
Don’t pick funds that charge more than 0.25% in total fees.
Fees and expenses are tricky. Dis-honest fund advertising will try to convince you that their fund makes so much money they can charge you 2%. Don’t be fooled. For a neutral opinion on the fee structures of funds, the SEC is a safe source of information:
All investments involve risk.
Standard wisdom in investing is that you need to diversify your assets. The market will ebb and flow, and when one investment dips you don’t want to lose everything. Don’t put all your money in Dutch Tulips.
Mutual funds seem like a good answer to this. By definition, they help you diversify where your money is invested. And if we look at the “Cap vs Growth” graph above we see an easy way to start thinking about how to diversify our assets even further.
An index fund (or “index tracker”) is a mutual fund designed to follow certain preset rules so that the fund can track a specified basket of underlying investments, like the S&P 500. These funds are run on very strict rules and require far lower operating costs.
The question is: are mutual funds really better than just a simple index fund?
There is an interesting story where Warren Buffet bet a million dollars to any hedge fund on Wall Street that they couldn’t earn more interest than a simple index fund over the next 10 years. Warren Buffet won the bet.
Of course, mutual funds are not hedge funds:
But this is a great example of the risk-vs-reward trade-offs. Most people believe index funds of the American economy have low risk in the long term.
There are lots of types of mutual funds. That is, there are lots of investment strategies followed by mutual fund managers.
For a quick intro to different types of funds checkout this Investopia article.
This was, of course, just a first encounter introduction to mutual funds. There are a lot of great resources out there to help you learn more to plan for your retirement, or whatever else your goals might be.
Why should you care about mutual funds? Well, mutual funds are a really common way to invest, especially for retirement. The tools below will help you organize your thoughts on how much you need to invest and what the best strategies might be.