Mutual Funds: A Popular Alternative to Individual Stocks and Bonds
Instead of investing directly in the stock market, you can buy mutual funds. An investment company creates a mutual fund by pooling investors’ money and using it to invest in an assortment of stocks, bonds, or cash. In a way, investing in a mutual fund is like hiring your own professional money manager.
The best part is that the fund manager who manages the mutual fund makes the buying and selling decisions for you. This is ideal for people who don’t have the time or knowledge to research individual companies and determine whether the stock is a good buy at its current price. This is one of the reasons that mutual funds have become so popular in the last few years.
For a relatively low fee, especially when compared with stock commissions, mutual funds give you instant diversification. For a minimum investment of $2500, or sometimes less, you can buy a slice of a whole basket of stocks. (Many mutual fund companies have raised their minimum from as little as $100 to $2500.)
If you are interested in mutual funds, you should begin by looking in the financial section of your local newspaper. There are well over 7000 mutual funds to choose from, each with its own style and strategy.
For example, you could buy a mutual fund that invests in stocks (called a stock fund), technology (a sector fund), or bonds (a bond fund), or one that invests in international stocks (an international fund).
No matter what kind of investment you’re interested in, there is a mutual fund that should meet your needs. When you find a mutual fund that meets your goals and fits your investment strategy, you send a check to the investment company.
Because there are so many mutual funds, you should take as much time to choose the correct mutual fund as you would take to choose a stock. Keep in mind that although most mutual funds did extremely well during the 1990s, many have faltered during the last few years. That’s why it’s important to find a fund that is successful even when the economy is doing poorly.
One of the smartest ways to invest in mutual funds is through a 401(k), a voluntary tax-deferred savings plan that is provided by a number of companies. The popular 401(k) plan is one of the reasons so many people became involved in the stock market to begin with.
The brilliant part of the 401(k) is that you don’t have to pay taxes on the money you earn until you are 591⁄2. If you leave the company before you’re 59 1⁄2, you can convert your 401(k) to an IRA, another type of tax deferred savings plan.
Why People Choose Mutual Funds
The main reason that people choose mutual funds is to allow diversification, which means that instead of investing all of your money in only one stock—a frequently risky move—you are able to buy a slice of hundreds of stocks.
For example, let’s say that most of your money was invested in WorldCom on the day it announced that it had misstated its earnings by $3.8 billion. The stock fell by over 90 percent in 1 day! If you had owned this stock directly, you would have lost 90 percent of your money.
On the other hand, if you owned a mutual fund that owned WorldCom, you might have lost no more than 3 percent of your money that day. Now do you see why mutual funds are a good idea for investors?
On the other hand, some people are looking for a whole lot more, which is what brings them to the stock market in the first place. If you owned a mutual fund that contained a stock that went up a lot in price in 1 day, you might make 1 or 2 percent on your fund that day. But if you owned the stock directly, you could make 10 or 20 percent, or perhaps more, in 1 or 2 days. (I’ve owned stocks that have gone up as much as 50 percent in 1 day.)
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