How do I Invest in Mutual Funds?

Investing in Mutual Funds Couldn't be Easier or More Affordable

If you've ever wanted to know how to invest in mutual funds, this quick explanation will help you get started.
If you've ever wanted to know how to invest in mutual funds, this quick explanation will help you get started. svetikd/Getty Images

Thanks to modern computers and the Internet, investing in mutual funds has never been easier, though there are many important considerations an investor should take into account before adding shares of a mutual fund to their portfolio.  Mutual funds come in a multitude of varieties including those that focus on different asset classes, those that seek to mimic an index (also known as index funds), those that focus on dividend stocks; the list goes on and on covering everything from geographic mandates to those that specialize in investing in securities that fall within a certain market capitalization.

 By answering the following three questions, it is my hope you'll gain a better understanding of what mutual funds are, how they work, and how they can be added to your investment portfolio.

What is a Mutual Fund?

As with any investment, the first order of business is to understand what it is that you are considering acquiring.  For all intents and purposes, mutual funds serve as an alternative for investors who can't afford an individually managed account.  Mutual funds are formed when investors with smaller amounts of capital pool their money together and then hire a portfolio manager to run the consolidated pool's portfolio, buying different stocks, bonds, or other securities in a manner consistent with the fund's prospectus.  Each investor then gets their respective piece of the pie while sharing the expenses, which show up in something called the mutual fund expense ratio.  Mutual funds can be structured in several different ways; open-ended mutual funds vs closed mutual funds being one particularly important distinction.

To learn more about the way mutual funds are organized, read How a Mutual Fund Is Structured. You may also want to read Making Money from Mutual Funds, which explains how investors actually profit (or experience losses) from owning a stake in a mutual fund.

How do I Select a Mutual Fund?

This is where you'll want to focus your attention and do a bit of sleuthing and research.

 The number of mutual funds available to investors now rivals the number of stocks on the North American exchanges; each one unique but can be categorized based on the type of underlying securities held within them. At the broadest level, a fund will fall into one of three categories, equity (stocks), fixed income (bonds), and money markets (similar to cash).  Equity and fixed income funds have subcategories, which will allow an investor to cast a narrow net with their investment dollars.  For example, an equity fund investor might invest in a technology fund that only invests in technology companies.  Likewise a bond fund investor who is seeking current income might invest in a government securities fund that only invests in government securities.  A so-called balanced fund is a mutual fund that owns both stocks and bonds.

Risk is an important consideration when evaluating mutual funds.  As an investor, you should make every effort to understand how much risk you are willing to take and then seek a fund that falls within your risk tolerance.  Naturally, you are investing with some objective in mind, so narrow down your list of candidates by concentrating on funds that meet your investment needs while staying within your risk parameters.

In addition, check to see what the minimum amount is to invest in a fund.  Some funds will have different minimum thresholds depending on whether it is a retirement account or non-retirement account.

How do I Buy a Mutual Fund?

The process of buying mutual fund shares is covered in-depth in How Do I Buy Shares of a Mutual Fund? but the summary version is this: Mutual funds are primarily bought in dollar amounts unlike stocks, which are bought in shares.  Mutual funds can be purchased directly from a mutual fund company, a bank, or a brokerage firm.  Before you can invest you will need to have an account with one of these institutions prior to placing an order.  A mutual fund will be either a “load” or “no load” fund, which is financial jargon for either paying a commission or not paying a commission.

If you are using an investment professional to assist you, you are likely to pay a load.  Understand that a “no load” fund is not free.  All mutual funds have internal expenses, which is to say that part of your investment dollars go to pay the fund company, the fund manager, and other fees associated with running a mutual fund.  These fees are often transparent to the investor and are taken out of the assets of the mutual fund.  You should consider all fees and charges when investing in mutual funds

The process of buying a mutual fund can be done over the phone, online, or in person if you are dealing with a financial representative.  To place an order, you would indicate how much money you want to invest and what mutual fund you want to purchase.  No matter the mutual fund, the price you pay for the shares will be determined by the closing share price at the end of that day.

This article was written by Marc Pearlman in May 2011.  It was subsequently edited for formatting and clarity by Joshua Kennon.  The Balance does not provide tax, investment, or financial services and advice.  The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors.  Past performance is not indicative of future results.  Investing involves risk including the possible loss of principal.