Mutual funds are confusing, right? They don’t have to be, The basics explained

Basics of Mutual Funds

Basics of Mutual Funds

Before you invest in any mutual funds, take the time to set your own investment goals and objectives and then plan an investment strategy to meet those goals. Remember, you are aiming to build a portfolio of mutual funds that suits your needs and situation. You’ll need to decide how much risk you can afford to take and what your time horizon will be. How much you’ll need to invest, and how aggressive you’ll have to be in putting your money to work, will depend on a number of factors: how much money you have available to invest; what financial goals you hope to attain with the funds you’re investing; when you need to tap your investments; and, finally, how comfortable you are with risk. Now let’s discuss the basics of Mutual Funds.

Surprisingly, getting all that accomplished is a lot easier than it sounds.

If there’s one area of financial planning for which the Internet is most useful, it’s taking the hard work out of number crunching. Guidance on virtually every financial planning decision you’ll need to make, from setting your goals (How much do I need to save for a new home/college tuition/retirement?) to achieving them (Should I be investing in aggressive mutual funds or stick with no-frills index funds?), can be found online.

The Basics of Mutual Funds involves calculating your retirement goals and the amount of time you’ve allotted to reach them, you will narrow the field of mutual funds that fits those guidelines. For instance, if you are saving for a retirement that’s more than 20 years down the road, you may want to invest largely in stock funds, possibly overweighting those that favor fast-growing but risky companies. If you stick to more conservative bond and money-market funds, your investment may not grow fast enough to meet your investment goals. On the other hand, if you’re a newly-wed hoping to buy your first home in the next five years, you’ll want to stay away from risky, aggressive mutual funds, because if the market is in slump when it comes time to sell, you may actually lose capital, and find that a house is out of reach.

Whether your investment profile points to a need for a more aggressive approach to investing or a more cautious one, the process of setting goals will sharply reduce the number of fund types you’ll need to consider when you begin your fund research. Indeed, knowing why you need to invest will help to make the decision of where you should invest much less complicated.

Sorting Through Mutual Funds

Once you’ve set a goal and calculated how much money you’ll need to invest to meet that goal, it’s time to start the search for those funds that best fit the bill. When winnowing down the types of funds you should be targeting and that suit your investment profile, you’ll need to compare the following factors to help you narrow the field of funds: past performance, total return, costs, and risk.

Past Performance: Headline-grabbing performance figures blaring out from advertisements and fund-rating lists are often the first thing that catches a prospective investor’s eye. A fund’s past performance is important, but not for the reasons you might think. Studies have shown that funds that put in top-ranking performance in one year often log better-than-average returns in the subsequent year. But that seems to be the extent of any performance persistence. While past performance is not a reliable indicator of future returns, volatility of past returns is a good indicator of a fund’s future volatility. If a fund you’re considering seems to seesaw from the top to the bottom of ranking lists and back again over time, it’s a good bet that that sort of volatility will continue in future years.

It is also important to look at past performance of the managers who run the funds you are considering. A fund that has been consistently hot wouldn’t seem as appealing if the fund manager who was making the stock picks suddenly left. Finding this kind of data isn’t as easy as finding data on fund performance. It is easy to check the five-year performance of Fidelity Magellan Fund, but not so easy to put your finger on the five-year performance of Robert Stansky, who has managed the fund since 1996. Still, many financial Web sites include information on how long a manager has been with a fund.

Total Return: Because the market is not static and fund values rise and fall each day, it’s important to look not only at the share price, but also at the fund’s total return. Total return measures not only gains and losses in the value of a fund’s share price, but also takes into account the reinvestment of any income and capital-gains distributions. Most fund prospectuses show a yearly total return figure for the most recent ten-year period. Comparing year-to-year changes in total return is a good way to see how stable the fund’s returns have been over time.

Costs: Figuring out how much a fund charges each year in fees and expenses can be a real headache, but it’s a crucial factor in your investment choice, because costs lower your fund’s overall return. A fund that charges an upfront load and high expenses has to put in a better performance than a low-cost fund, just to stay even. There are two main categories of costs to consider: sales loads and transaction fees, and ongoing annual fund expenses.

Risk: Every investment involves risk, and it’s important to determine how much risk is appropriate for any fund that you are considering. Even funds of the same type can have significantly different levels of risks. For example, funds that have put in the best performances throughout the bull market of the 1990s, such as technology and Internet sector funds, usually are ranked very low in terms of risk-adjusted performance.

Put another way, investors were exposed to an extreme level of volatility in return for those stellar returns. Fund-rating services such as Morningstar and Value Line rank risk in terms of beta, a measurement of how volatile a fund is in comparison to a benchmark market indicator, such as the Standard & Poor’s 500-stock index. A fund with a beta of higher than 1.0 (1.0 = the benchmark index) would be expected to outperform the market, while one below that figure would likely underperform. But a beta of greater than 1.0 also means the fund is volatile. In bad times, the value of these funds may fall much more than the major market indexes.

Screening Mutual Funds

It could take hours to plow through the pages of just a handful of mutual fund prospectuses to find the ones that are best for you, taking into consideration all of the factors outlined above. But luckily, resources found on the Internet do much of the work for you. Many fund Web sites offer interactive tools that collect data on thousands of funds and then let you “screen” or pinpoint the types of funds that most directly suit your needs. Say, for instance, you’re interested in investing in a growth fund that has a low minimum initial investment and low expenses, yet ranks high in performance over the last five years. A screening tool will drill down into its database of growth funds and provide a ranking of the ones that come closest to matching those variables.

Here is how it works: Each screening tool is somewhat different — and some of the most powerful are tricky and may take some time to get used to — but the basic concepts are the same for all. Essentially, you fill out a form on a Web page that tells the screening tool just what you aim to find. The first question on many screens is a basic query as to what categories of funds you are interested in. Using a drop-down menu — those Web site mainstays that, with a click of a mouse, expand to reveal a list of options or choices — you may select simply “stock funds.” Or you may narrow your preference, selecting “growth,” or narrower still, “small company growth.”

From there, you specify other criteria that are important to you in selecting a specific small-company growth fund. Using a drop-down menu again, or perhaps a box on the Web site where you can simply type in your preferences, you may specify that you’d like to see only the small-company growth funds that gained more than 10% last year. In a separate box, you may specify that you want only funds that charge a modest sales charge — say, less than 1% of the amount you invest. And you may want a fund that allows a small initial investment. You may select “less than $1,000” from that menu.

Once all of your selections are made, the screening tool will begin its search. Behind the scenes, it taps into enormous databases of information held in computers at the Web-site operator. Poured into those databases is information from thousands of funds’ prospectuses, annual reports, and other documents — the information that fund companies are required to disclose to the Securities and Exchange Commission on a regular basis — as well as data on fund performance and the performance of benchmark stock indexes. Within seconds, the computer sorts through the nuggets of information you are most interested in and returns a list of funds that meet your criteria.

If the list is too long, you may want to refine your search. If the search comes up empty, it may be time to adjust your goals (maybe you better aim for a somewhat smaller return or accept a somewhat larger sales charge). Once you have a manageable list, you can continue your research — and perhaps prepare to make a purchase. Some of the best sites also offer links to prospectus information on the funds, allowing you to perform an even more detailed comparison once you’ve narrowed your search to a few funds.

Screening tools are among the most popular and useful resources available to mutual fund investors on the Web. They put the power of research — which just several years ago was available only through financial planners and brokers — on the desktop of any investor with an Internet connection. Screening is offered at sites run by fund companies, brokerage firms, newspapers, magazines, and scores of research firms — including many upstarts that owe their existence to the Net.

If you’ve already trimmed your search to a handful of funds, and would like to compare just those using one particular variable, such as volatility, turnover (the rate at which a fund buys investment positions and then sells them), and one-, three-, and five-year return, try’s Fund Analyzer (

Fund screens and analyzers can also highlight any overlap you may have in your portfolio. For example, if you find that the performance of your large-company growth fund closely tracks your technology fund, there may be a good reason — both could be holding large positions in widely held technology stocks, such as Microsoft or Intel. That kind of overlap in your investment portfolio can be risky, particularly in times of a protracted market slump. Currently, the SEC requires that mutual fund companies report on their funds’ top ten holdings only once each quarter. A number of fund companies have set up Web sites that provide more timely fund data and rating information to users for free. But the best information generally isn’t on the Web sites run by fund companies.

Making the Trade

There’s no reason to log off when you are finally ready to use all of the research and analysis that you have done on the Net. You can buy and sell shares of thousands of funds through Web sites run by online brokerage firms, and some fund companies themselves. But it isn’t all as straightforward as buying or selling a stock online, where any brokerage firm can trade any stock listed on a public market and commissions are generally uniform within each firm. Not all mutual funds can be bought or sold at all brokerage firms, even the biggest and most well established. Further, commissions and fees can be confusing. Many brokerage firms charge commissions on purchases of funds that come without an initial sales charge, or load, when purchased directly from the fund family. In some cases, those fees can be high, at $20 or more per trade.

The variety of funds that are available, as well as the commissions that are charged on transactions, differ from one brokerage firm to another, so it pays to do some research on firms’ Web sites before trying to place an order. Unlike the stock market, where transactions are funneled through a major stock exchange or the Nasdaq Stock Market, there is no open public market for mutual funds. So the fund availability from any given brokerage firm comes down to the relationships it has struck with fund firms. The firms that have most relationships, the greatest selection, and, they’d contend, the best prices, have come to be known as fund supermarkets.

But setting up an account at a fund firm, or an online brokerage firm, isn’t as easy as pointing and clicking. An investor can’t open an account online, because fund companies must have a customer’s signature on file first. Savvy fund companies are at least trying to cut down on the waiting time by allowing prospective customers to download and print out a sign-up form, making it easier to fill out the form and mail in a check quickly.

Another obstacle in quickly setting up an online account is the transfer of funds. While customers can authorize an electronic transfer of funds from their savings or checking accounts, that process can take several days. And federal regulations bar customers from using a credit card to open an account. Once an account is established and the initial funds are in place, though, online trading can greatly speed subsequent mutual fund transactions — especially within a fund supermarket.

Using Mutual Fund Company Web Sites

In the past, fund companies were slow to embrace the Internet, wary of security issues and the substantial costs involved in adding major Web site enhancements.

But the pace has been picking up rapidly as more upstart Internet brokers convince droves of online investors to do their shopping at fund supermarkets. According to an October 1997 survey of 187 U.S. fund companies by the Investment Company Institute, half of those companies had created Web sites, but few had adopted the latest bells and whistles. The ICI represents about 95% of the mutual fund industry in terms of assets.

Still, most fund company Web sites provide a lot of marketing information, but little else. As recently as 1998, only one third of existing fund company Web sites allowed investors to download fund prospectuses, and roughly 20% provided service forms or account applications. While 25% of the mutual fund Web sites let investors access personal account information, only 11% of the sites allowed investors to move money among different funds within the family. And just 5% provided bulletin boards where clients can chat with mutual fund managers, executives, or one another.

Despite these dismal numbers, investors continue to cite a fund company’s Web site as their preferred method for contacting their representatives and getting the latest information on the fund company’s management and investment strategy. A survey conducted by in mid-1998 of users of its Web site showed that 27% of respondents picked fund company Web sites as the most efficient way to communicate with a fund company, although many said they have a hard time finding what they need quickly.

Tellingly, an overwhelming number of respondents said they’d choose a fund company’s Web site over a toll-free phone number late at night, when telephone customer service often is unavailable or understaffed. By contacting the fund company by e-mail, investors can get responses to their questions in writing, which tend to be more detailed, and often much more accurate, than responses given by representatives over the phone. One drawback, however, is that electronic communication between funds and clients still takes far too long to process. Many messages tend to go unanswered, and a 24-hour wait for a response is standard.

Big Mutual Fund Families Lead the Charge

There have been some significant improvements in many major fund family sites. Fidelity Investments, of course, runs a massive site where one can buy and sell its more than 150 mutual funds, or shop its FundsNetwork supermarket, offering hundreds of funds run by other firms. Dreyfus ( offers account access for investors who want to view their balances. And it has added detailed fact sheets on all Dreyfus funds, including daily performance numbers.

The Janus Funds site ( allows users to trade funds electronically. The revamped site also includes links to daily performance figures, account histories, Morningstar rankings, and a monthly address from Jim Craig, Janus’s chief investment officer. T. Rowe Price is another company whose site ( has been improving. You’ll find Fund Fact sheets with a summary, performance data, and charts comparing each fund with its benchmark, as well as market reports and calculators.

At Safeco’s site (, investors can check fund returns and asset balance, and tap into real-time online customer service support. Vanguard, whose site ( ranks among the best fund company entries the Internet has to offer, features an asset-allocation program, Navigator Plus. Just input your personal information, and the program generates a customized investment allocation.

The Internet provides mutual fund companies with the unique opportunity to keep clients updated on changes in the market that may effect fund performance. For example, in times of increased market volatility, a fund company might try to ease concerns among new investors by keeping them updated with running market analysis. Or a fund site could give clients a heads up soon after changes are made in the fund’s top 10 holdings.

But the sad truth is that relatively few fund companies take full advantage of the Internet’s potential to reach clients. A survey of some of the largest fund companies’ Web sites shows a wasteland of dated and quite often useless information, or data that can be found for free at hundreds of more comprehensive financial Web sites.

While most fund companies feature their latest quarterly reports, a surprising number of sites serve up data more than six months old. Even more frustrating is the trend among fund companies to offer crucial information about the fund, such as its prospectus and most recent annual performance data, in a mammoth downloadable file that requires Adobe Acrobat — a software program used to view computer files that are essentially a snapshot of a printed page — and, depending on the speed of your Internet connection, a lot of time to spare. Citing security reasons, few companies have been willing to allow their clients to access account information online.

One area where fund company sites appear to be of use to their customers is tax information, including details on mutual fund year-end distributions. Mutual Fund Education Alliance maintains a list of fund companies that have posted their annual distributions, both estimated and actual, on their Web sites.

At Vanguard’s Web site, shareholders have the option to “shut off paper” on their accounts, or stop postal mailings of fund materials and quarterly reports, and instead receive e-mailed notifications of when fund reports and other notices are available online.

Keeping Track of Mutual Funds

Another key in the Basics of Mutual Funds is to keep close tabs on your portfolio, you can figure out whether your investments are paying off — or whether you should sell some laggard holdings and maybe even change your investment strategy.

Keeping track of your mutual fund investments has never been easier, thanks to the Web. Mutual fund NAV quotes and portfolio-tracking tools, featured on practically every financial-planning and investment Web site, allow you to update your portfolio’s value daily, so you can see day by day exactly how your investments are performing. Many sites offer online portfolio trackers free to investors who’ll register with the site to use them, and for a small fee several sites offer trackers with features that for some may be worth the cost. Try out trackers on a couple of your favorite investment sites to find the one you like best.

Investor Guide includes a list of sites that feature exceptional portfolio-tracking resources available through various financial Web sites, via e-mail or by downloading proprietary software. Investor Guide also helpfully separates the free from the fee-based services, and gives a brief description of each tool. Sites that offer the option to receive an end-of-day e-mail summary of your portfolio can be valuable to investors who want a quick and easy update on their investments.

Another important aspect of keeping track comes when you buy, sell, or transfer shares and funds electronically. Every time you buy or sell shares in a fund, you should receive some form of confirmation from your fund company, either by e-mail or postal mail. Check carefully to be sure that each trade was completed according to your instructions. Check to see that the correct number of shares are bought or sold, and make sure the buying or selling price is charged as quoted. Be sure the commissions or fees are what your broker said they would be.

Most important, watch out for “unauthorized” trades in your account. If you receive a confirmation slip for a transaction that you didn’t approve, call the fund company representative immediately. It may have been a mistake. If it happens more than once, or if your broker refuses to correct it, call the SEC or your state securities regulator.

Cogratulations, you should now understand the Basics of Mutual Funds.

One Response to Mutual funds are confusing, right? They don’t have to be, The basics explained

  1. Janessa says:

    I was definitely confused by mutual funds, and this made it a little easier to understand. Thanks

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