Are mutual funds safe? They can protect your investments
When you invest in the stock market, there is always a certain level of risk. The market goes up and down, and you may sometimes find your investments going from green to red and vice versa.
But investing in the stock market has more advantages 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 allow you to buy several stocks or bonds at once, for a fixed amount and relatively low fees. They come in two types: active and passive funds. Passive funds track an index, such as the S&P 500, and they are also known as index funds. Active funds mean that a fund manager is behind the computer to buy and sell securities and build a portfolio to beat the market.
The great thing about mutual funds is that when you invest in them, your money is spread among hundreds, if not thousands, of different companies, instead of a select few. This is called diversification and it can help protect your investment if a business takes a turn for the worse.
Of course, all investments involve risk and you can lose money in a mutual fund. But that’s not likely, especially if you’re diverse. There are also other risks to consider. Before investing, it is always important to do your research. Read on to find out why mutual funds are safe to invest in and some of the pros and cons of mutual funds for investors.
Are mutual funds risky?
As with any type of investment, mutual funds involve a certain level of risk. As long as you’re diversified in your investments, know what you’re investing in, and have a long-term perspective, you have a good chance of making money.
Timing is important. Think of investing as a long-term game. Try to hold onto your stock market investments for as long as you can to let compound interest do the work for you. The stock market is always changing, and if you don’t need your funds right away, chances are the stock market will go up and you’ll recoup your losses (and more). That’s why it’s best to invest in mutual funds to get money that you know you won’t need for the next five years or so.
Here are some other mutual fund risks you should be aware of.
High fees: Passive mutual funds have low fees, but beware when investing in active funds as they are more expensive. It’s because of the human behind the scenes selecting your investments. Experts agree that passive mutual funds are a great choice for investors.
Liquidity risk: You cannot quickly withdraw your money from mutual funds. Mutual fund shares can only be traded once per day, unlike ETFs, which can be bought and sold throughout the exchange’s trading hours. This means that each day you only have the opportunity to buy and sell once. Some funds may also have additional holding period requirements or account minimums on top of the normal buy/sell cycle. For this reason, mutual funds are considered the best for long-term investments.
Management risk:, If you choose an actively managed mutual fund, there is a bit of additional risk on top of the fees. Let’s say you have a good fund manager and they leave, says Ashley Coake, certified financial planner and founder of Cultivate Financial Planning, and the next manager isn’t so good. This is a risk over which you have no control. Before deciding to invest in a mutual fund, you can research the team first.
Mutual funds are generally less risky than investing solely in stocks. However, the level and type of risk depends on the types of investments 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 that other mutual funds do. 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 around 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, generally carry higher risk than mutual funds. In turn, experts agree that it’s probably best not to pick individual stocks. This is especially true if you are just starting out. If you invest all your money in buying shares of one company and it has a lousy year in terms of performance, the value of your investments will take a hit. But if you invest in mutual funds rather than stocks, diversification will spread your risk and protect your portfolio.
Are mutual funds safer than ETFs?
Mutual funds and ETFs essentially do the same thing: lead you to financial independence. An ETF, or exchange-traded fund, also allows you to buy an entire group of stocks or bonds in one purchase. Since the two are so similar, it’s best to do your research and find out what stocks and bonds are in this fund.
Remember that no matter what you decide to invest in, it’s important to note that every investment will have reward potential and risk potential, says Michael Anderson, 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,” Anderson says. “You have to be careful not to go into investments willy-nilly. You want to understand what you’re getting, what the goals are, what the risks are.
Anderson recommends printing out the two-page fact sheet of any mutual fund you decide to invest in. It will tell you what you are investing in and, in fairly simple terms, describe what the investment team is trying to do with the assets they’re putting in the basket.
Advantages of Mutual Funds
Here are some common reasons investors love 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 are exposed to when investing in the stock market and protects your investments.
Low minimum investments: With mutual funds, you can diversify for a relatively low price, Coake says. “So if you’re looking to invest your first $100, and you’re looking for stocks that you can choose 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 all this wide variety of investment options, whether it’s stocks, bonds or whatever, and you pay a certain amount in dollars.” Minimums vary with each fund. Some funds have no minimums at all, and others have minimums ranging from $3,000 to $10,000.
At low price: Passively managed mutual funds are relatively inexpensive compared to other types of investments. Many mutual funds have expense ratios, or fees, below 0.05%. This is music to the ears of an investor. Anything over 1% is high, so be sure to check the fees before investing.
Reinvestment of dividends: When you receive dividends from your mutual funds, you have the option of automatically reinvesting them back into the fund. In return, your investment continues to grow.
You can buy a fixed amount: Because you’re buying into the mutual fund and not the individual securities that make up the mutual fund, you’re buying at the fixed dollar value, Coake explains. “If you have X dollars, with the mutual fund, you have $100, you walk in and say, I’d like to buy $100 of this mutual fund and you buy it and you’re done,” Coake explains. This advantage makes automatic investments a little easier.