How do you make money with mutual funds? First, it's important to understand that investors don't "make" money, at least not in the literal sense. "Making money" is an expression that most commonly refers to earning money, as with a job, profession, or line of work that pays a wage or salary in exchange for labor or the production of a good or service. But making money with mutual funds and most other investment securities can be better described as the growth of capital—your investments are worth more when you sell than they were when you bought them.
Therefore, when someone asks "How do you make money with mutual funds?" they're really asking three related and overlapping questions: "How do you buy mutual funds?" "Which mutual funds are the best for growing my money?" and "What is the best way to grow my money with mutual funds?"
Buying Mutual Funds
Buying mutual funds is relatively simple, but there are a few steps that responsible investors should take before buying them. First, you want to know the purpose of your investment. This purpose is described as an investment objective, which outlines your reasons for buying mutual funds. Sure, you probably want to make money, but what specific reason do you have for investing? Examples of investment objectives can include college or retirement savings.
After you know your investment objective, you can start the process of deciding where you will invest in mutual funds. This decision begins with the choice of investing it yourself or using an advisor. Since you're reading this article, you're probably leaning toward the do-it-yourself route already. Fortunately, mutual funds are easy to buy without the assistance of an investment advisor or stockbroker.
Assuming you don't want the help of an advisor to make money with mutual funds, you can invest through one of the best no-load mutual fund companies, such as Vanguard, Fidelity, and T. Rowe Price, or through a discount broker like Charles Schwab or Scottrade.
Once you've opened an account with a financial institution–which may be an individual brokerage account, a joint brokerage account, or an individual retirement account (IRA)–the actual process of buying a mutual fund is straightforward: generally, one logs into their account online, selects the mutual fund they want and the amount they want to invest in it, then they execute the trade. Keep in mind that some mutual funds have minimum initial purchase amounts. There are plenty of no-minimum funds available, but it isn't uncommon for a fund to require an initial investment of $1,000 or more. After the first investment, the minimum requirements usually decrease. For example, a mutual fund may require a minimum initial investment of $1,000, but investments after that can be made in increments of $100.
Choosing the Best Funds
The best mutual funds for making money are the ones that you are comfortable holding, even when the market falls. How do you know which funds are best for you? You can start with an assessment of your risk tolerance by using a risk tolerance questionnaire. This will help you gauge how much you can handle without selling shares in a panic.
Once you know your investment objective and you know your risk tolerance, you can choose the best funds for you. Essentially, you'll invest in the funds that can earn the most without taking so much risk that you'll be uncomfortable. Take a look at a fund's returns over various timelines, then compare those returns to the fund's risk assessment. Funds will usually promote their risk level using phrases like aggressive (most risky), conservative (least risky), and balanced.
While performance and risk are the two biggest factors for most investors, don't forget to read the fine print, and look for fees and extra costs. No-load funds, which are funds that don't include a commission or sales charge, are usually best for do-it-yourself investors. Avoiding commission fees helps reduce the barriers to entry, and the funds usually have the lowest expense fees, as well. The difference between two funds' fees may only be a fraction of a percent, but that fractional difference adds up year after year, and it ultimately translates into you making more money.
Best Practices For Mutual Fund Investment
If you want to make money with mutual funds, one of your most powerful resources is time. Since the prices of mutual funds fluctuate, the value of your investment can go up and down, and these fluctuations are most pronounced in the short term. For example, the odds of making money with mutual funds in just one day in the market is essentially a toss of a coin—the price is almost as likely to go up in a day as it is to go down. However, by looking at mutual fund prices over the course of a year, chances are that your investment has made money (but it's still a gamble). By watching your mutual fund investments over a long period of time, especially 10 years or more, the chances of seeing your investment appreciate in value (which is another way of saying "making money") are higher than 90%.
Therefore, the best way to make money with mutual funds is not in fund selection or timing, but with long-term holding. As the saying goes, "time in the market is better than timing the market."
Along with this buy-and-hold strategy for mutual funds, successful mutual fund investors continue buying shares of their chosen funds during the holding period. Put simply, you make more money with mutual funds when you add more money to your shares. It can seem counterintuitive to buy more shares when prices hit all-time highs, but when you buy shares periodically, such as once per month, you're doing something called "dollar-cost averaging." According to this strategy, investors are better served over time by consistently buying, rather than trying to save up cash and time massive buys to take advantage of short-term market fluctuations.
The Bottom Line
To summarize, the best way to make money with mutual funds is to use time as your ally by investing early, holding for the long-term, and continuing to buying shares frequently. Push yourself to invest as aggressively as you can without losing sleep at night worrying about the stock market. Once you set the ball in motion on investing in mutual funds, you can let your portfolio do the work while you go about your life.
Now you're ready to build a portfolio of mutual funds and start making money!