Wondering how to get started with mutual funds? There’s something you need to know first.
Here at Cabot, we get a lot of questions from new investors wanting to know how to get started with mutual funds. Mutual funds have been part of their employer-sponsored 401(k)s, but they are ready to do some investing on their own. Mutual funds seem like a good place to start, since it’s something most people are somewhat familiar with. You might be one of these investors. Maybe you’ve seen ads for a mutual fund in your favorite magazine or your retirement account coordinator at work may have suggested some mutual funds to you.
Before you read any further, though, you need to make a choice. You are welcome to go along happily with these recommendations. They may even lead you to an investment that regularly beats the market index. And hey, if you have the money to pay someone to actively manage your retirement fund, then who are we to judge?
But you have another option.
How to get started with mutual funds and retire comfortably
Spoiler alert: If you continue reading because you really want to know how to get started with mutual funds, you are going to be sorely disappointed.
But first, let’s start by defining mutual funds. Mutual funds offer professional management by an investment company, with big research departments and plenty of intellectual firepower in their economic forecasting staff.
If you’re a mutual fund manager, you pick an index to use as a benchmark. This might be the Dow, the S&P 500 or the Nasdaq or an index that tracks a particular market or sector. The Dow is slightly more conservative, the S&P is taken to represent the broad market and the Nasdaq is weighted toward tech stocks, which gives it a little more volatility.
So, the first step for a mutual fund in beating the index is to essentially buy the index. Large mutual funds usually hold (almost) every stock in their benchmark index, matching both the holdings and the weightings of the index.
In this way, mutual funds offer investors an organized method for diversifying their portfolios. They can give you exposure to well-known stocks that may be otherwise unaffordable, and they help you lower your overall risk.
And now, with online services, it’s easier than ever to invest in a mutual fund without even going through a broker. The only cost is the mutual fund management fee. So if you’re really interested in learning how to get started with mutual funds, it’s as simple as getting an account at your favorite online trading site, like E*TRADE or TD Ameritrade, and buying into a fund. So what’s the problem?
In short, with just a little effort, most investors can get better returns by investing in a small, diversified portfolio of stocks than they can with a mutual fund. Why? Mutual fund managers keep their jobs by outperforming the index they follow. To make big gains, they would have to take some risks. Over time, of course, the stock market goes up, so a few losses here and there won’t severely impact a diversified portfolio for long.
However, when your job as a mutual fund manager is simply to beat the index, why would you take a chance? Especially given that because mutual funds hold dozens and dozens of stocks, a big winner will only make a small contribution to total performance.
How to get started investing without mutual funds (and actually retire comfortably)
Okay, now that we’ve convinced you to forget about learning how to get started with mutual funds and go for the big wins that a smart, diversified portfolio can offer, what should you do? The first thing we would recommend is downloading and reading through our free report, How to Invest in Stocks: How Stocks Work, How to Calculate Return on Investment and Other Investing Basics.
Here’s the very short version: If a business is fundamentally strong (i.e. it actually makes money), has a diversified product line, and is in a solid position in its market, you are 90% of the way to finding a good investment. The remaining 10% is just a matter of looking at a few parameters – no matter what the company does – to determine if it’s the best stock for your investment dollars.
This all comes with one caveat: The usual approach used by most 401(k) and IRA investors – lots of index funds, wide diversification, never change a thing, and rely on the effects of time and continuing contributions to build value – is exactly right for many investors. However, picking stocks individually allows you to be more nimble, more specific, and more diversified – and make more money.
As we always say at Cabot Wealth, nobody cares more about your money than you. So why let someone else make your investment decisions for you?
What are your thoughts on mutual fund investing? Share your thoughts in the comments below.