When you invest in the stock market, there is always some level of risk. The market goes up and down, and you may sometimes find your investments going from in the green to red and back again.
But investing in the stock market has more upsides than not. Not investing is detrimental to your long-term financial journey. Mutual funds are a great way to get started and are safe to invest in if you follow some key points.
Mutual funds are investments that let you buy multiple stocks or bonds at once—for a flat dollar amount and a relatively low fee. They come in two flavors: active and passive funds. Passive funds track an index, like the S&P 500, and they’re also known as index funds. Active funds means a fund manager is behind the computer buying and selling securities and building a portfolio that’s meant to beat the market.
The great thing about mutual funds is that when you invest in them, your money is spread out among hundreds, if not thousands, of different companies, instead of a select few. This is known as diversification, and can help protect your investment should one company take a turn for the worst.
Of course, all investments carry risk and you can lose money in a mutual fund. But it’s not likely, especially if you’re diversified. There are some other risks to consider, too. Before investing, it’s always important to do your research. Read on to learn why mutual funds are safe to invest in and some of the advantages and disadvantages of mutual funds for investors.
Are Mutual Funds Risky?
Just like with any type of investment, mutual funds carry a certain level of risk. As long as you are diversified in your investments, know what you’re invested in, and have a long-term perspective, you carry a good chance of making money.
Timing is important. Think of investing as a long-term play. Try to keep your investments in the stock market as long as you can so you can let compound interest do the work for you. The stock market is always changing, and if you don’t need your funds immediately, there’s a good chance the stock market will come back up and you’ll recoup your losses (and then some). That’s why mutual fund investing is best for money that you know you won’t need in the next five years or so.
Here are some other risks associated with mutual funds that you should look out for.
High Fees: Passive mutual funds have low fees, but beware when investing in active funds as they are more expensive. This is because of the human behind the scenes picking your investments. Experts agree going with passive mutual funds is a great choice for investors.
Liquidity risk: You can’t pull your money out of mutual funds quickly. Mutual funds shares can only be traded once a day, compared to ETFs, which can be bought and sold throughout the stock exchange’s trading hours. That means every day you only have the ability to buy and sell once.. Some funds might also have additional holding period requirements or account minimums on top of the normal buy/sell cycle. For this reason, mutual funds are considered best for long-term investing.
Management risk:, If you choose an actively managed mutual fund, there’s a bit of extra risk on top of the fees. Let’s say you have a great fund manager and he leaves, says Ashley Coake, a certified financial planner and founder of Cultivate Financial Planning, and the next manager isn’t so great. That’s a risk you have no control over. Before you decide to invest in a mutual fund, you can research the team first.
Mutual funds are typically less risky than investing in just stocks. However, the level and type of risk depends on what types of investments are in a particular mutual fund.
What Are the Safest Mutual Funds?
Because index funds are passively managed mutual funds, they don’t have some of the risks as other mutual funds. Index funds also tend to be more predictable and consistent in their returns over time. The S&P 500 has a rate of return of about 10% each year, so investing in a total market index fund is a great choice for investors.
Are Mutual Funds Riskier than Stocks?
Individual stocks, because they lack diversification, typically carry greater risk than mutual funds. In turn, experts agree that it’s probably best not to pick individual stocks. This is particularly true if you’re just starting out. If you put all your money in buying shares of a single company, and they have a rotten year performance-wise, the value of your investments will take a hit. But if you invest in mutual funds instead of stocks, diversification will spread out your risk and will protect your portfolio.
Are Mutual Funds Safer than ETFs?
Mutual funds and ETFs essentially do the same thing — lead you towards financial independence. An ETF, or exchange-traded fund, also allows you to buy a whole group of stocks or bonds with one purchase. Since the two are so similar, it’s best to do your research and know what stocks and bonds are within that fund.
Remember that no matter what you decide to invest in, it’s important to note that every investment is going to have potential for reward and potential for risk, explains Michael Anderson, a certified financial planner and founder of Maranantha Financial.
“People will always tell you at a cocktail party about their winners, how they made so much money on a certain investment, but they’ll never tell you about their losers,” says Anderson. “You’ve got to be careful about just jumping into investments willy-nilly. You want to understand what you’re getting, what the objectives are, what the risks are.”
Anderson recommends printing out the two-page fact sheet of whatever mutual fund you decide to invest in. It will tell you what you’re investing in, and in fairly simple terms describe what the investment team is trying to do with the assets they’re putting into the basket.
Pros of Mutual Funds
Here are some common reasons why investors like mutual funds:
Diversification: When you invest in a mutual fund, you can add hundreds or thousands of assets to a portfolio. Diversification reduces the risk you’re exposed to when you invest in the stock market and protects your investments.
Low minimum investments: With mutual funds you can get diversified for a relatively low price, says Coake. “So if you’re looking to invest your first $100, and you’re looking for stocks that you can pick to try to diversify and invest in as many companies as you can, for $100, you’re going to be pretty limited,” says Coake. “With the mutual fund, you get this whole wide variety of investment options, whether it’s stocks or bonds or whatever, and you pay a certain dollar figure.” Minimums vary with each fund. Some funds have no minimum at all, and others have minimums anywhere from $3,000 to $10,000.
Low cost: Passively managed mutual funds are relatively low cost compared to other types of investments. Many mutual funds have expense ratios, or fees, that are less than 0.05%. This is music to the ears of an investor. Anything that’s over 1% is high, so be sure to check the fees before investing.
Dividend reinvestment: When you earn dividends from your mutual funds, you have the option of automatically reinvesting them so they go back into the fund. In turn, your investment continues to grow.
You Can Buy a Fixed Dollar Amount: Because you are buying into the mutual fund and not the individual securities that make up the mutual fund, you buy at the flat dollar value, explains Coake. “If you have X amount of dollars, with the mutual fund you have $100, you go in and say, I would like to buy $100 of this mutual fund and you buy it and you’re done,” says Coake. This benefit makes automatic investments a bit easier.