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What Are Mutual Funds?

If the mere mention of the phrase mutual funds has your eyes glazing over with confusion, trust us—you’re not alone. We’ve all been there. The good news is, they’re not as complicated as you may think. 

With the help of an investment professional, mutual funds are a great way to invest for your retirement. But you should never invest in something you don’t understand. So let’s take a closer look at what mutual funds are, how they work, and how they can become the most valuable tool in your retirement investing strategy.

What Is a Mutual Fund?

Simply put, mutual funds are professionally managed investment portfolios that allow investors to pool their money together to invest in something.

It may help to think of it like this. Imagine a group of people standing around an empty bowl. They each take out a $100 bill and place it in the bowl. These people just mutually funded that bowl. It’s a mutual fund. Makes sense, right?

Mutual funds are professionally managed investment portfolios that allow investors pool their money together to invest in something.

Now, what the money is used to invest in will tell you what kind of fund it is. If I go out and use the money to buy stock in international companies, then the fund would be an international stock mutual fund. What if I decided to buy bonds? Then it would be a bond mutual fund. See? Not that complicated!

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Inside a typical growth stock mutual fund are stocks from dozens, sometimes hundreds, of different companies—so when you put money in a mutual fund, you’re basically buying bits and pieces of all those companies. Some of those company stocks may go up while others go down, but the overall value of the fund should go up over time. And as the value of the overall fund goes up, so do your returns!

One of the great things about mutual funds is that you don’t have to have a lot of money to get started, and—thanks to their diversity of investments—you can invest confidently because all of your retirement eggs aren’t in one basket.

How Do I Buy a Mutual Fund?

There are a few different ways to invest in mutual funds. If it’s an option for you, the best place to start is the retirement plan offered at your work, like a 401(k). Why? Because it comes with plenty of benefits like:

  • Tax-deferred growth of your investments—or tax-free growth if you have a Roth 401(k)

  • An employer match to your contributions that instantly doubles the amount of money put into your 401(k) every paycheck

  • Automatic contributions from your paycheck

When you’re looking over the mutual fund options included in your workplace plan, work with your financial advisor to select the best ones. Once you’ve made your selections, invest as much as it takes to receive the full employer match.

If you don’t have a workplace retirement plan, or you’ve maxed out your employer’s match, you can invest in mutual funds through a Roth IRA with the help of an experienced investment professional.

Your goal is to invest 15% of your income for retirement. That’s a big goal that you’ll need to stay focused on long-term, so keep working with your investing pro to make sure you stay on track.

Types of Mutual Funds

Let’s take a closer look at the different types of mutual funds. Today, more than $17.7 trillion of assets like stocks, bonds, cash and money market accounts are held in more than 8,000 mutual funds—and that’s just in the U.S. alone!1 

Each of those funds has its own specific investing strategy, and each comes with its own risks and rewards. With so many mutual funds to choose from, trying to pick the right ones might feel overwhelming—kind of like trying to pick a meal from a massive menu.

Now, there are many different types of funds out there, but we recommend investing evenly across four different types of mutual funds: growth and income, growth, aggressive growth and international funds. Let’s take a closer look at each.

1. Growth and Income

Growth and income funds, sometimes called large cap funds, are mostly made up of stocks from big companies—including some you’ll probably recognize, like Apple or Microsoft—that are valued over $10 billion. They’re more predictable and the calmest type of funds available. Although their returns aren’t always as high as other funds, they’re what many consider to be a low-risk, stable foundation for your portfolio.

2. Growth

Growth funds are just what they sound like: They’re funds invested in medium to large companies that still have room to grow. You’ll sometimes see these funds listed as mid cap funds. Even though they have a knack for rising and falling with the economy, growth funds are pretty stable overall and usually earn higher returns than growth and income funds.

3. Aggressive Growth

Aggressive growth funds—sometimes called small cap funds—are the "wild child" of mutual funds. When they’re up, they are really up, but when they’re down—watch out! Made up of stocks from companies with a lot of potential for growth (like small tech start-ups or large companies in emerging markets), they’re your chance to take a big risk for a potentially bigger financial reward.

4. International

Did you know plenty of American household names are not American at all? Gerber, Trader Joe’s, Frigidaire appliances and Holiday Inn are all foreign-owned businesses. By including international funds in your mutual fund portfolio, you can benefit from the success of well-known companies overseas.

What Costs Come With a Mutual Fund?

Nothing is ever really free—and mutual funds are no exception. Mutual funds pass along their costs to investors through all sorts of investment fees and other expenses—things like shareholder fees, operating expenses, front-end load fees, purchase fees, back-end load fees, redemption fees, exchange fees and account fees.2

Fees are a fact of life when it comes to investing, so your goal is to choose mutual funds that perform well and have reasonable fees. This is exactly why you need a pro in your corner.

A good investment professional can help you understand the costs that come with investing and how they will affect your end result. They’ll not only work with you to understand your financial goals, they’ll help you understand those "hidden" fees so you can avoid surprises that could eat away at your nest egg!

How Much Risk Is Involved With Investing in Mutual Funds?

Listen, there will always be some level of risk involved when you’re investing. That’s just part of the deal. But there are a few ways you can reduce the risk of investing so you can sleep a little easier at night.

1. Look at the fund’s long-term history.

When deciding on a mutual fund, it’s important look at its history and how it’s performed over the last 10 to 20 years—not just the last year or two. It can be tempting to get tunnel vision and focus only on funds that brought stellar returns in recent years. Instead, take a deep breath, step back, and look at the big picture.

2. Compare similar mutual funds.

You’ll also want to understand how the mutual fund has performed compared to other similar funds in the market over long periods of time. Is it at least keeping up with a good benchmark like the S&P 500, or has it been performing so badly that it’s making even the "worst" funds look good? All in all, to lower your risk, you want to choose a fund that has a long-running track record of strong returns.

3. Diversify, diversify, diversify.

Whenever you hear the word diversification, that just means you’re spreading your money around. Mutual funds, which are filled with stocks from many different companies, already have a certain level of diversification built into them.

And when you add another level of diversification by spreading your investments across those four different mutual fund types mentioned earlier, you lower your risk even more.

Even when you diversify, it’s not always going to be sunshine and rainbows when it comes to investing for retirement. There are going to be some good days, and there are going to be some bad days. But choosing a good mix will help you build a weatherproof retirement that will help you get through those rainy days.

Planning for Your Retirement With Mutual Funds

You don’t have to camp out on the trading floor of the New York Stock Exchange to get smarter about your retirement. Mutual funds are a straightforward, affordable way to begin investing for the long haul.

No matter what is happening with the stock market, our advice is the same: Invest in the right mix of mutual funds with a history of strong performance, and stick with them over time.

No matter what is happening with the stock market, my investing advice has remained the same: Invest in the right mix of mutual funds with a history of strong performance, and stick with them over time.

If you’re ready to take control of your financial future, then it’s time to sit down with a SmartVestor pro. You can work with an investing professional as you select your funds, devise a long-term investing strategy, and stick with that strategy whether the stock market is swinging up or down. Your pro will help make sense of your investing options and walk you through the process so you can set real goals.

Find your SmartVestor pro today!


Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.

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