Mutual funds are a great way to spread your risk over many different stocks without having to invest thousands of dollars. It is important to do some research on how mutual funds work and what to watch for when evaluating mutual funds.

A mutual fund is a company that pools money from many different investors and invests that money in stocks, bonds, money-market instruments or a combination of different investment assets. Each investors share represents a portion of the assets contained within the mutual funds holdings.

Investors purchase mutual funds from the fund itself or from other brokers. The price is determined by the mutual funds net asset value (NAV). The price paid is the NAV + the associated commissions and fees which the fund has. Mutual funds can be sold back to the fund or to the broker which markets the fund. The investment manager determines which percentage of different stocks the fund has and which stocks. This is determined somewhat based on the mission statement of the fund. This advisor is held to that statement for his decisions.

When you purchase stock from a broker, you end up paying for that broker’s commission and the fees for the firm he or she works for. The same applies to mutual funds. Each mutual fund carries with it fees that need to be paid. These fees can be annual fees, on purchase fees, at exit fees. It is important to review the fees associated with a mutual fund, so the investment becomes as profitable as it can be. There are different classes of funds and the fees are different for each class. The classes are Class A, Class B or Class C shares.

Some negative things about mutual funds are the lack of control over the fund. The investment manager makes the decisions on what to purchase and how much. The industry invested in is also based on the funds mission statement. The costs associated with the fund can also be a bad thing. Even if the fund is losing money, the fees are always there. The value of the fund is also an uncertainty. With stocks, you can watch the value by the minute. The value of the mutual fund is generally calculated after the market closes. Until the value is determined you really do not know what you have. Also when you initiate a purchase, you really do not know the price you are paying for the fund. It is determined after the close of business on the day you placed the order.

Stock funds are not all the same. They fall into different classes. For example, there are funds which invest only in growth funds. Some invest in dividend producing funds. There are also funds which are known as index funds. These index funds invest in the market as a whole. For example, the S&P 500 index fund follows what the S&P 500 is doing. Funds can also invest in specific industries and are known as Sector funds.

There are basically three ways to make money with a mutual fund. One is based on the dividends paid out by the holdings. Another is when a stock being held is sold. The capital gain is distributed, usually at year-end, to the investors. Also an increase in the NAV will create an increase in the funds value.

All funds carry a degree of risk. Before investing, it is important to read the prospectus and review what levels of risk the fund carries, what it is authorized to do with your funds and what the fee structure is. A review of the investment manager’s resume and success ratio is also warranted.

It is also important to remember that a fund may have a banner year and be in the toilet the next. Even an impressive ten year history is no indication that the fund will continue to do well. As with stock purchases, it is important to review the industries the funds invests in and if those industries are currently growing. In late 2008, investing in financials or real estate would not have been a good idea.

You should also balance your investments to reduce your risk. You should set a goal on how many funds you will purchase, the strategy each fund will have and your percentage holding in each fund. At the end of the year, one fund may have increased in value by 30% while another fund decreased by 10%. Your determined percentage holdings is now out of balance. Sell some of the fund that increased in value and buy more of the fund which decreased. Bring the percentages back in line. Doing this at the beginning of January of each year will be beneficial to you.

To summarize then. To make your mutual fund investments work for you, read the prospectus carefully (it is boring but needs to be done), read the other information provided that details how the fund has and is doing, reduce the fees, choose growing or dividend paying funds, balance your portfolio annually.

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