Buying Mutual Funds

Table of Contents
Chapter 1: Introduction to Mutual Funds
Chapter 2: Categories of Mutual Funds
Chapter 3: Understanding Mutual Fund Terminology
Chapter 4: Mutual Fund Costs
Chapter 5: Buying Mutual Funds
Chapter 6: Tracking and Selling Mutual Funds

Navigate This Page
Chapter 5: Buying Mutual Funds
Where to Buy Mutual Funds
How to Select the Right Fund
Risk Factors

Chapter 5: Buying Mutual Funds

You now have a basic understanding of what mutual funds are, what are the different types and what are the costs associated with them. These are some critical aspects that should consider before you buy mutual funds.

Buying a mutual fund is not the same as buying stocks, both in terms of the fund selection process and the buying process.

Where to Buy Mutual Funds

Most mutual fund companies have a website which can give you the details of all the funds managed by them. Initial costs, loads, portfolio and fund manager’s credentials will be available online. You can compare products within the same company or from different companies easily to identify the ones which will give good returns and have low costs. You can purchase funds directly from companies through online transactions.

Most of the funds are also available through brokerages, banks and other agents. Although, they will charge a fee for the transaction, they will offer some useful tools like giving you a consolidated view of your investments. Several established brokerages allow you to track your investments online with their portfolio management software. You can also sign up with agents who offer a number of funds to choose from.

How to Select the Right Fund

The track record of a fund is not the only thing to consider when making an investment decision. There are many aspects which go into finding the fund that is right for you:

  • Your Investment Goals: The first step is to have clarity on your investment goals. This will determine the kind of fund you should invest in. If your need is for a consistent income then a bond fund may be the right option for you. If your aim is long term growth in your investment amount then a growth fund is ideal.

  • Expertise of the Fund Manager: A manager who has proven his worth with a good track record is a valuable asset to any fund. Check the performance of funds headed by the same manager in the past to get an idea of his expertise.

  • Costs: The costs you will incur, in the form of load or other charges will reduce your net earnings from the funds. These must be factored into the expected returns advertised to get an accurate idea of your actual gains.

  • Underlying Securities: The fund’s risk levels must match your risk appetite. Study the portfolio allocation of the fund to get an idea of the risks inherent in the investments. Remember that the risks of the fund depend on its underlying assets. You can look at the fund’s prospectus to gain a detailed idea of the investment strategy which will be followed.

  • Age of the Fund: New funds can sometimes have a successful streak before they settle down into a more subdued returns pattern. Check if the fund you are interested in has been in existence for more than 4- 5 years so that you have a better idea of its long term performance. You should look for a consistent return generation pattern over the years.

An analysis of the fund’s performance in previous years can give a fair idea of how the fund reacts to various market changes. New funds or those which so far only have a small portfolio can be unpredictable. Remember that such new funds may see spectacular returns even if one of the investments is successful. However, for larger funds with more diversifications, the gains are also spread across many investments like the risks and this can lower the returns.

  • Tax Implications: Any capital gains which a fund gets are distributed to shareholders evenly. The shareholders must pay taxes on their portion of these gains. Check the distribution pattern and schedule of a fund before you invest in it to avoid paying taxes on capital gain distributions as soon as you invest. Postpone your investment until after distributions are made if possible.

  • Returns: Returns are the most important factor to consider before you purchase a fund. The annualized return which represents the average return from the fund over a term of several years is a good figure to base your decision on. Keep in mind that the performance of the underlying assets determines how well or how poorly the fund performs.

Keep these factors in mind when shopping for the right mutual fund to invest in. You should also consider the general predictions for key industries that the fund invests in, the overall condition of the economy and your own financial needs.

Risk Factors

Like any other investment, mutual funds also have some risks associated with them. Here are some of the risk factors that you should know about:

Mutual funds come with as much risk as the individual securities that make up the fund portfolio. But because these risks are spread over many different investments, there is a lesser chance of the entire portfolio taking a major hit.

Do not automatically assume that a mutual fund with a good track record is a sure winner. The performance of the underlying investments determines the fate of the fund and that can change anytime. Even a mutual fund which performed extremely well in the past may see big losses in the future, depending on how well its investments perform and the direction in which the economy moves.

Mutual funds are not backed by FDIC support or any other kind of insurance. This is a common misconception that investors have, especially with funds which are promoted by banks.

Next Chapter: Tracking and Selling Mutual Funds