How to Make Money With Mutual Funds

The Basic Steps of Buying Mutual Funds and Making Money Over Time

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Learn how to make money with mutual funds. Getty Images

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. In the conventional 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 basically described as the growth of capital (i.e. money you invested that is worth more when you sell it than it was when you bought it).

Therefore, when someone asks the question, "How do you make money with mutual funds?," they're really asking three related and overlapping questions: "How do you buy mutual funds?," and "What is the best way to grow my money with mutual funds?," and "Which mutual funds are the best for growing my money?" And those are the three basic questions about investing in mutual funds that we'll address here:

Making Money With Mutual Funds Step One: Buying Mutual Funds

Buying mutual funds is relatively simple but there are a few responsible steps to take prior to buying them. First, you want to know the purpose of your investment. This purpose is described as an investment objective, which basically outlines your reasons for buying mutual funds and what you specifically want them to do for you other than just make money. Examples of investment objectives include education savings or retirement.

After you know your investment objective, along with a few other important aspects of buying mutual funds described below, you can start the decision process of where you will invest in mutual funds.

This decision begins with the choice of investing it yourself or using an advisor. Fortunately, mutual funds are simple enough to invest in and buy without the assistance of an investment advisor or stock broker. And since you're reading this article, you're probably leaning toward the do-it-yourself route already.

Assuming you want to make your money with mutual funds without an advisor, 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. No-load funds are usually best for do-it-yourself investors because they usually have the lowest expenses, which can translate into making more money with mutual funds in the long run, compared to more expensive load funds.

Once you've opened an account, 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 will generally involve logging in to your account online, selecting the mutual fund you want, and executing the trade, which will usually specify a certain dollar amount. Keep in mind that many mutual funds have minimum initial purchase amounts of more than $1,000. After the initial purchase, you can typically buy as little as $100 worth of mutual fund shares at a time.

Making Money With Mutual Funds Step Two: Best Practices

If you want to make money with mutual funds, one of your biggest resources is time. Since mutual funds can fluctuate up and down in price, 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 almost a toss of a coin; making money over the course of one year is higher than 50% odds but still a gamble; but making money with mutual funds over a long period of time, especially 10 years or more is higher than 90% odds.

Therefore the best way to make money with mutual funds is not in fund selection or in timing but with long-term holding. As the saying goes, "time in the market is better than timing the market." And along with this buy-and-hold strategy for mutual funds, you'll need to continue buying shares of your chosen funds during the holding period. Put simply, you make more money with mutual funds when you add more money to your shares. And when you buy shares periodically, such as once per month, you'll do something called dollar-cost averaging, which can also help grow your money over time.

Making Money With Mutual Funds Step Three: 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 with something called a risk tolerance questionnaire. This will gauge how much you can handle without selling shares in a panic.

Once you know your investment objective, as discussed in Step One above, 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.

In summary, the best way to make money with mutual funds is to use time as your ally (invest early in life), continue buying shares frequently, and be as aggressive 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!