Who Should Invest in Mutual Funds?
Mutual funds are suitable for a variety of different people at various points in their lives. They are generally preferred by investors who lack a large amount of money for investment, or those who don’t have the time to research the market, but want to grow their wealth.
Are There Any Fees for Mutual Funds?
There are a variety of fees that you may be charged for having a mutual fund. These can include sales load, expense ratio, redemption fees and transaction fees. A financial planner can help you understand what costs are associated with mutual funds and how they will affect your end goal.
What’s a Good Net Expense Ratio for Mutual Funds?
An expense ratio is an annual fee that is a percentage of your investment that goes toward the mutual fund’s expenses. For example, if you invest in a mutual that has a 0.5% expense ratio, you’ll pay $5 per year for every $1,000 invested. A good net expense ratio for mutual funds is usually less than 1% if you invest in large companies and less than 1.25% if you invest in smaller companies.
This money will come from your investment in the fund rather than you being sent a bill. This means that you need to keep a close eye on this to make sure that your net expense ratio is not too high. Even a small change in the net expense ratio can cost you a lot of money in the long run.
Do You Pay Taxes on Mutual Funds?
It’s important to know the tax implications for mutual funds. If you own mutual funds in a taxable account, such as a brokerage account, then you will need to pay capital gains tax when you sell shares of the fund if it has increased in value since purchase.
You also may need to pay taxes on shares sold within the fund even though these are not realized. The fund manager can buy and sell within the fund and you will be sent a tax form to report gains on your income taxes each year.
You will also pay yearly taxes on dividend payouts even if you reinvest them.
You can get around this by owning the funds in a tax-advantaged account such as a Roth IRA.
Which is Better: Active or Passive Mutual Funds?
Most mutual funds are actively managed by an investment professional but it is possible to invest passively. Actively managed means that the investment professional does most of the heavy lifting and tries to beat the stock market’s average returns and take advantage of short-term price fluctuations.
Passive investors are usually invested for the long haul and have a “buy and hold” mentality. They don’t buy and sell as frequently as active investors which generally means that it’s a more cost-effective approach.
One approach is not necessarily better than the other. Only a small number of actively managed funds ever do better than passive funds. Talk to your financial advisor about which mutual fund investment strategy may be best for you.
How Do You Make Money From a Mutual Fund?
You can make money from mutual funds in three different ways.
- Income is earned from dividends on stocks and interest on bonds. A mutual fund pays out nearly all of the net income it receives over the year in the form of a distribution.
- An increase in the price of securities. This is called capital gain.
- The fund share price (NAV) increases. The higher NAV reflects the higher value of your investment. If you sell your shares then you will make a profit. This is also called capital gain.
You are usually given the choice of whether to receive a payment for distributions or have them reinvested in the fund to buy more shares. Every decision comes with different tax implications so it’s important to discuss your options with your financial advisor.
