Want to get started investing? Experts say your best move is to ignore headlines about hedge funds and Bitcoin and focus on a cheap convenient vehicle that’s been around for decades: mutual funds.
“A mutual fund rolls up other securities inside of it like stocks or bonds and offers a simplified option for investors,” says Matthew Fleming, senior financial advisor at Vanguard Personal Advisor Services.
Most mutual funds follow one of two basic investment strategies. Active funds aim to find winning stocks (or bonds), often with the help of a team of analysts that interviews executives and pours over company financials. Passive, or index, funds follow market benchmarks like the S&P 500, aiming to keep costs low while delivering market-matching returns.
According to the the Investment Company Institute, a fund industry trade group, nearly 60 million American households own mutual funds, accounting for one-fifth of their overall financial assets. Over the course of 20 years, the total wealth in mutual funds has ballooned to nearly $20 trillion from just over $7 trillion. Here’s why investors keep showing them love:
1. They’re convenient
Mutual funds offer investors, even those with very little experience, an easy way to grow their savings without any fuss. Regardless of whether you choose to invest in an actively managed or passive fund, you don’t have to do much work once you buy in.
Buying into a fund is also a fairly simple endeavor. If you have a workplace retirement plan like a 401(k) or 403(b), chances are that the options on the investment menu are mutual funds. You can also buy mutual fund shares through an account at a brokerage firm like Charles Schwab or TD Ameritrade or sometimes directly from mutual fund companies. Another possibility is to pay a financial advisor or robo-advisor to invest for you, but you’ll have to pay additional fees for their services.
But just because it’s an “easy” way to invest doesn’t mean you’ll be getting rich overnight. Most mutual funds are designed for long term investors — think a decade or more — with some, like target date funds, built around the assumption you will own them until you retire.
The good news is, there’s no need to track daily stock market moves. A hands-free approach may help you avoid the pitfalls of trading securities as an individual, where one poorly timed move can leave you saddled with big losses. “From a behavioral standpoint, [mutual funds] pull you back and remove you from the timing element,” says Fleming.
2. They help you diversify
Mutual funds, both actively and passively managed, make it easy to build a portfolio that includes dozens of stocks or bonds for a small upfront investment, often around $1,000 to $2,000, although there are many funds available for even less.
While some funds invest in one specific sector like energy or healthcare, others take a more broad-based approach, tracking large market indexes like the Russell 3000, which seeks to measure the performance of the largest 3,000 U.S. stocks by market value. Most investors, especially beginners should start broad, according to Fleming. “Most advantage for individuals comes when you buy a broader-based index because it’s going to capture all of those sectors,” he says.
Maintaining a diverse investment portfolio is an important way to minimize risk in your investment portfolio. That’s because while stocks and bonds can deliver consistent long-term returns, in any given year particular industries — and some times the stock market as a whole — can see big ups and downs. Owning different types of stocks, and mixing in some bonds, helps to make sure that any given moment your portfolio will includes some temporarily hot and some temporarily cold stocks, smoothing your overall returns.
3. They’re Cheap
The aim of investing is to make money. So the less you can spend doing it, the better off you are.
Mutual funds typically charge an annual fee, quoted as an annual percentage of the amount you have invested in the fund. Anywhere from less than 0.1% ($10 for every $10,000 invested) for broad-based index funds to 1% or more ($100 for every $10,000 invested) for actively managed funds. There may be additional fees if you buy funds through a financial advisor, broker or robo-adviser.
Of course, buying a stock directly means you pay no fee at all. (Although you may pay a trading commission and are certain to pay implicit fees known as bid-ask spreads.) But considering mutual funds give you access to hundreds or even thousands of stocks and bonds through a single purchase, most investors, even sophisticated ones, consider that few dollars a year well worth it.
Most experts recommend sticking with mutual funds that are less expensive, particularly index funds. A good rule of thumb is to aim to pay no more 0.3% ($30 per $10,000 invested) for a domestic stock fund. (International mutual funds tend to be a bit more expensive.)
Worried about missing out on big gains if you don’t hire an expensive fund manager? Studies show most active funds actually fail to outperform index funds, once you factor in their higher fees.