by Liz Kudwa
A: Well you are not alone. Many people have money deducted from their paychecks to be put into a 401(k). Generally, your money is invested in a mutual fund of some sort. Mutual funds are really a way for the ‘average Joe’ to get a piece of the stock market. If you invested in a bunch of stocks separately, you’d be checking the stock pages of the Wall Street Journal for each stock, checking to see if you were making a profit. But with a mutual fund, there is a fund manager to do that for you.
Essentially, a mutual fund is a collection of stocks and bonds and there are three ways you can make money. First, you can receive income from dividends on stocks or interest on bonds. Second, if the fund sells securities (stocks and/or bonds) that have increased in price, then the mutual fund has a capital gain. And third, if the mutual fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit.
There are several advantages to having your money go into a mutual fund. First, as I mentioned before, mutual funds are professionally managed. You don’t have to worry about making sure your investments are profitable.
Second, mutual funds are diversified. This helps to spread your risk out across many different industries. In other words, your eggs aren’t all in one basket. Third, mutual funds offer economies of scale. Since large amounts of stocks and bonds are bought or sold all at one time, your costs are less. And fourth, mutual funds offer liquidity. You can convert your shares into cash at any time.
Now that you have a little more information on mutual funds, they may sound like a pretty solid investment. And I think they can be, but there are a few disadvantages to them too. It all depends on what your investing goals are. While it is an advantage, having a professionally managed mutual fund can be a disadvantage too. Fund managers don’t always make the right choices. Second, there can be hidden costs when investing in a mutual fund. Beware and make sure you read the fine print. Third, if your mutual fund is very successful and grows to a large size, your investment can become diluted…you can be too diversified. And fourth there are taxes that you have to pay. Fund managers don’t always think about your personal tax situation when they make decisions. When a security is sold, a capital gains tax is triggered, which affects how much profit you will make.
We have several books at the library that can offer you with additional information on the topic of mutual funds. I strongly encourage you to check these out so that you are armed with as much information as possible.
o Mutual Funds: A Quick-Start Guide by Entrepreneur Press And Jason R. Rich
o Mutual Funds For Dummies by Eric Tyson
o Morningstar Guide To Mutual Funds: Five-Star Strategies For Success edited by Christine Benz
o The Individual Investor’s Guide To The Top Mutual Funds
o Stop Wasting Your Wealth In Mutual Funds: Separately Managed Accounts: The Smart Alternative by Don F. Wilkinson
o Mutual Funds: Your Money, Your Choice: Take Control Now And Build Wealth Wisely by Charles P. Jones
Elizabeth Kudwa is the Business Reference Librarian at the Capital Area District Library located at 401 S. Capitol Avenue in Lansing, MI. Contact her at 517-367-6301 or by e-mail at kudwae@cadl.org.
