Mutual Funds For Dummies

Eric Tyson

• Publisher: For Dummies
• Year: 2022
• Print ISBN: 9781119881766
• eBook ISBN: 9781119880462
• Edition: 8
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Build substantial wealth with mutual funds (and ETFs)!

Mutual funds and exchange-traded funds (ETFs) are great for professional management, diversification and liquidity into your portfolio, but what are the costs and risks? And how have the best investment strategies changed with the rise of robo-investing, ETFs, and new tax rules? Mutual Funds For Dummies answers all your questions, giving you insight on how to find the best-managed funds that match your financial goals.

With straightforward advice and plenty of specific fund recommendations, Eric Tyson helps you avoid fund-investing pitfalls and maximize your returns. This new edition covers the latest investment trends and philosophies, including factor investing, ESG investing, and online investing. You'll also find completely updated coverage on the best mutual funds and ETFs in each category.

Earn more with funds!

• Learn how mutual funds and ETFs work and determine how much of your portfolio to devote
• Weigh the pros and cons of funds, and use funds to help you pick your own stocks
• Make the most of online investing and other new technologies and trends
• Maximize your gains by choosing the funds and strategies that work for you

Mutual Funds For Dummies is a trusted resource, and this update has arrived to help you plan and implement a successful investment strategy. The fund market is rebounding—get on the train and take advantage of the opportunity today!

Part 1

Getting Started with Funds

IN THIS PART …

Understand investment options, risks, rewards, and diversification.

Discover the pros and cons of mutual and exchange-traded funds.

Get your financial house in order before investing in funds.

Chapter 1

Making More Money, Taking Less Risk

IN THIS CHAPTER

Defining mutual funds and exchange-traded funds

Understanding lending versus ownership investments

Weighing your options

Seeing the big picture: Returns, risks, and risk reduction

In my years of work as a financial advisor, educator, and a columnist answering many readers’ questions, I’ve seen the same, avoidable mistakes being made over and over. Often, these investing mistakes occurred for one simple reason: a lack of investment understanding. People didn’t know what their investing options were and why particular options were inferior or superior to others.

By reading this book, you can prevent yourself from making investment mistakes. And you can take advantage of an excellent investment vehicle: mutual funds — the best of which offer you diversification, which reduces your risks, and low-cost access to highly diversified portfolios and professional money managers, who can boost your returns with less risk. Funds are a vehicle to help you achieve your financial and personal goals. Mutual funds and exchange-traded funds can fit nicely in the context of your overall financial plans and goals. This chapter gives you an investment overview so you can see how mutual funds and exchange-traded funds fit into the overall investment world.

Introducing Mutual Funds and Exchange-Traded Funds

If you already understand stocks and bonds, their risks and potential returns, and the benefits of diversification, terrific. You can skip/breeze through some of this chapter. Most people, however, don’t really comprehend investment basics, which is one of the major reasons people make investment mistakes in the first place.

After you understand the specific types of securities (stocks, bonds, and so on) that funds can invest in, you’ve mastered one of the important building blocks to understanding mutual funds and exchange-traded funds. A mutual fund is a vehicle that holds other investments: When you invest in a mutual fund, you’re contributing to a big pool of money that a mutual fund manager uses to buy other investments, such as stocks, bonds, and/or other assets that meet the fund’s investment objectives.

Exchange-traded funds (ETFs) are a very close relative of mutual funds and differ from them in one particular way. ETFs trade like stocks on a stock exchange and thus can be bought or sold during the trading day when the financial markets are open. (In Chapter 2, I explain one exception to this rule. A type of mutual fund, known as a closed-end fund, which accounts for a mere 1 percent of mutual fund assets, trades on a stock exchange during the trading day and has a fixed number of shares outstanding.)

Differences in investment objectives are how funds broadly categorize themselves, like the way an automaker labels a car a sedan or a sport utility vehicle. This label helps you, the buyer, have a general picture of the product even before you see the specifics. On the dealer’s lot, the salespeople take for granted that you know what sedan and sport utility vehicle mean. But what if the salesperson asks you whether you want a Pegasus or a Stegosaurus? If you don’t know what those names mean, how can you decide?

Fund terms, such as municipal bond fund or small-cap stock fund, are thrown around casually. Fact is, thanks to our spending-oriented culture, too many folks know car models better than types of funds! In this chapter (and in Chapter 2), I explain the investment and fund terms and concepts that many writers assume you already know (or perhaps that they don’t understand well enough themselves to explain to you). But don’t take the plunge into funds until you determine your overall financial needs and goals.

Making Sense of Investments

Your eyes can perceive dozens of different colors, and hundreds, if not thousands, of shades in between. In fact, you can see so many colors that you can easily forget what you discovered back in your early school days — that all colors are based on some combination of the three primary colors: red, blue, and yellow. Well, believe it or not, the world of investments is even simpler than that. The seemingly infinite number of investments out there is based on just two primary kinds of investments: lending investments and ownership investments.

Lending investments: Interest on your money

Lending is a type of investment in which the lender charges the borrower a fee (generally known as interest) until the original loan (typically known as the principal) gets paid back. Familiar lending investments include bank certificates of deposit (CDs), United States (U.S.) Treasury bills, and bonds issued by corporations, such as Chipotle.

In each case, you’re lending your money to an organization — the bank, the federal government, or a company — that pays you an agreed-upon rate of interest. You’re also promised that your principal (the original amount that you loaned) will be returned to you in full on a specific date.

The best thing that can happen with a lending investment is that you’re paid all the interest in addition to your original investment, as promised. Although getting your original investment back with the promised interest won’t make you rich, this result isn’t bad, given that the investment landscape is littered with the carcasses of failed investments that return you nothing — including lunch money loans that you never see repaid!

Lending investments have several drawbacks:

• You may not get everything you were promised. Under extenuating circumstances, promises get broken. When a company goes bankrupt (remember Bear Stearns, Enron, Lehman, Sears, WorldCom, and so on), for example, you can lose all or part of your original investment (from purchased bonds).
• You get what you were promised, but because of the ravages of inflation, your money is simply worth less than you expected it to be worth. Your money has less purchasing power than you thought it would. Suppose that you put $5,000 into an 18-year lending investment that yielded 4 percent. You planned to use it in 18 years to pay for one year of college. Although a year of college cost $5,000 when you invested the money, college costs rose 8 percent a year; so in 18 years when you needed the money, one year of college cost nearly $20,000. But your investment, yielding just 4 percent, would be worth only around $10,100 — nearly 50 percent short of the cost of college because the cost of college rose faster than did the value of your investment.
• You don’t share in the success of the organization to which you lend your money. If the company doubles or triples in size and profits, the growth is good for the company and its owners. As a bondholder (lender), you’re sure to get your interest and principal back, but you don’t reap any of the rewards. If Elon Musk had approached you years ago for money for his then new company Tesla, would you rather have loaned him the money or owned a piece of his company?

Ownership investments: More potential profit (and risk)

You’re an owner when you purchase an asset, whether a building or part of a multinational corporation, that has the ability to generate earnings or profits. Real estate and stock are common ownership investments.

Ownership investments can generate profits in two ways:

• Through the investment’s own cash flow/income: For example, as the owner of a duplex, you receive rental income from tenants. If you own stock in a corporation, many companies elect to pay out a portion of their annual profits (in the form of a dividend).
• Through appreciation in the value of the investment: When you own a piece of real estate in an economically vibrant area or you own stock in a growing company, your investment should increase in value over time. If and when you sell the investment, the difference between what you sold it for and what you paid for it is your (pre-tax) profit. (The IRS, of course, will eventually expect its share of your investment profits.) This potential for appreciation is the big advantage of being an owner versus a lender.

On the downside, ownership investments may come with extra responsibilities. If the furnace goes out or the plumbing springs a leak, you, as the property owner, are the one who must fix and pay for it while your tenant gets to kick back in their recliner watching football games and eating nachos. And you’re the one who must pay for insurance to protect yourself against risks, such as fire damage or accidents that occur on your property.

Moreover, where the potential for appreciation exists, the potential for depreciation also exists. Ownership investments can decline in value as we saw happen in the early 2000s, late 2000s, and in early 2020. Real estate markets can slump, stock markets can plummet, and individual companies can go belly up. For this reason, ownership investments tend to be riskier than lending investments.

Surveying the Major Investment Options

When you understand that fundamentally two major kinds of investments — ownership and lending — exist, you can more easily understand how a specific investment works … and whether it’s an attractive choice to help you achieve your specific goals.

Which investment vehicle you choose for a specific goal depends on where you’re going, how fast you want to get there, and what risks you’re willing to take. Here’s an inventory of investment vehicles to choose from, along with my thoughts on which vehicle would be a good choice for your situation.

Savings and money market accounts

You can find savings and money market accounts at banks; money market funds are available through mutual fund companies. All are lending investments based on short-term loans and are about the safest in terms of short-term risk to your investment among the various lending investments around. Relative to the typical long-term returns on growth-oriented in...

Table of contents

• Cover
• Title Page
• Table of Contents
• Introduction
• Part 1: Getting Started with Funds
• Part 2: Evaluating Alternatives to Funds
• Part 3: Separating the Best from the Rest
• Part 4: Crafting Your Fund Portfolio
• Part 5: Keeping Current and Informed
• Part 6: The Part of Tens
• Appendix: Recommended Fund Companies and Brokers
• Index
• About the Author
• Advertisement Page
• Connect with Dummies
• End User License Agreement