How to Buy Mutual Funds
In this post, we’ll discuss some best practices when it comes to purchasing index funds and mutual funds, in general. Mutual funds are a great option for those who don’t have the time or savvy to purchase stocks or other types of investments. First, let’s cover some basics on mutual funds.
What is a Mutual Fund?
A mutual fund is an investment vehicle that pools money from investors and then invests that money into a combination of investment vehicles, usually in the form of stocks, bonds, and money market accounts. Mutual funds are popular investments because they allow you to diversify your money into multiple investments in order to limit your risk exposure. Also, they are managed by professional investors, and if you have a good one you can sleep easy at night.
What is the Difference Between an Index Fund and a Mutual Fund?
Index funds are a type of mutual fund that attempts to mimic the performance of a stock market index. Like a mutual fund, index fund share values are based on the net asset value of all of the stocks they have invested in. Rather than its holdings being regularly bought and sold through managed trades, index funds periodically change investments based on a set of rules or infrequent committee selected changes.
What is the Difference Between a Mutual Fund and an ETF?
An ETF is a fund that follows an index and is traded throughout the day and the price is determined through the buying and selling behavior for that ETF, while a mutual fund is only traded once at the end of the day, with it’s share price determined by taking the overall share price value of all its holdings. ETF’s are usually passively managed in following an index while a mutual fund can be actively or passively managed (index fund).
Where Can I Buy Mutual Funds?
In a previous post, we discussed how to make a stock trade. Just like a stock, you can purchase mutual funds through online brokers. Additionally you can call the individual fund companies to invest directly through them if you have a fund in mind. This is usually a great way to avoid broker transaction fees.
How Can I Buy Mutual Funds?
If you’ve purchased mutual funds through an employee sponsored retirement plan, such as a 401K, the process of purchasing a fund on your own is slightly different.
- Step 1: Choose a discount brokerage
- Step 2: Submit funds to your discount brokerage account
- Step 3: Select the mutual fund that you’d like to buy. Pay attention to which mutual funds your discount broker is offering transaction fee free.
- Step 4: Choose the right funds. Look for characteristics like low expense ratios (under 1.2%), no load fees, managers with good track records who have been at the fund for a while, and funds that meet or beat their category averages. You may be limited by the amount you have to initially spend to purchase the fund. These amounts vary by type of account. If you have an IRA you will usually have to pay less to start than a non tax-sheltered account.
- Step 5: Purchase the fund. You enter in a total dollar amount that you’d like to apply towards the fund, vs. a price that you’d like to pay as you do when you purchase a stock. The price you will end up paying per share will be the closing price on the day that you purchase the fund. The amount you submit to purchase is divided by that share price to determine how many shares of the fund you will be vested in. You will also need to decide whether you would like your dividends, capital gains, or both reinvested into additional shares. If you’re young and have many years of investing ahead of you, there’s little reason to not choose ‘both’.
- Step 6: Adding to your Holdings: Once you’ve completed your up front minimum contribution you are free to add more funds at a lower contribution level (typically $50 or so, but some have no minimums).
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