Mutual Fund Basics

You need to understand these mutual fund basics before you can pick them for your 401k or personal accounts.

Mutual funds are the main investments of a person’s 401k and possibly IRA accounts. Yet many people ignore what they have in their 401k, just pick this and that fund and then forget and hope they do well without really understanding what they own.

The Different Types of Mutual Funds

  • Growth: These funds hold stocks that are for capital growth. These stocks are the up and coming type of companies, like Microsoft in the past when they first started. These funds are sometimes more risky than value funds but offer more upside return than a value fund.
  • Value: These funds hold stocks of companies that are believed to be undervalued and expecting to turn up soon. These stocks in the value fund are believed to be less risky than the stocks in a growth fund.
  • Blend: A blend fund has a mixture of both growth and value stocks in them.
  • Index: Is a fund that tracks a certain index. For example an S&P 500 index fund will follow that of the S&P500 index, or the DOW 30 index.
  • Bond: Bond funds own just bonds. These bonds can be any kind of bond from US bonds to corporate bonds with a varying degree of safety depending on the rating of the bonds. Also international bond funds, which buy bonds in countries outside of the United States.
  • International, global and emerging market: These funds hold mainly stocks of companies in countries outside of the US and Canada.
  • Sector: These funds can be of all kinds of sectors such as oil, gold, mining, real estate, precious metals and commodities. For example a gold fund will hold the stocks of companies involved in gold producing and mining.

There are also differences in categories of these funds. In all of these funds, there are these differences.

Large cap, mid cap and small cap are the main differences.

Cap means capitalization, the size of the company, capitalization is computed by the number of outstanding shares times the share price, so if XYZ stock has 1 million shares outstanding and its share price is $5 per share, its capitalization is $5 million.

What is a mutual fund load fee.

There are no-load mutual funds and front-load and back-load mutual funds. A load is a sales charge and or fee. There are several types of loads that a mutual fund will charge and it can get confusing.

Mutual Fund Classes and load fees:

  • Front end: This is a charge you pay as soon as you buy this fund. If for example you buy a fund that has a 4 % front-end load, you are immediately down 4%. This fund has to go up 4 % before you are break even. These are usually Class A shares.
  • Back end: Sometimes also called deferred load funds. These funds don’t (usually) charge a front-end fee, but they charge the fee when you sell the funds. So if you’re up 6% on a fund and you decide to sell the fund, and this fund has a back-end fee of 5%, after selling your fund you actually only gained 1%. This type of fund might charge you 5% when you sell the fund after owning it for 1 year and 4% after two years until after 5 years they don’t charge you for selling the fund. The back end fee is often called a Redemption fee.
  • Level load: Usually charges 1% each year you own the fund. They can also charge a rather high redemption fee.
  • No-Load: These funds don’t charge a load or sales charge/fee when buying or selling.

The Mutual Fund Expense Ratio: This is the cost of running a fund. Usually anywhere from .15% to 3%, when you look at expense ratios, compare them to funds in the same category. Usually the expense ratio is higher in the small cap funds. Index funds should have the lowest expense ratio since the manager does little stock picking of his own as these funds track their particular indexes. The expense ratio is applied every year.

Make sure you understand the mutual fund's loads/sales charge before putting any money into a mutual fund.

Many times in a 401k fund, the front end and or back end loads will be waived so check with the company managing your 401k.

If given the choice, I always choose no-load funds, studies have shown that load funds don’t do any better than funds with a sales charge/load and in most cases the no-load funds do better in the 3, 5 and 10 year returns.

Returns, what the fund did in a time period such as 1, 3, 5 and 10 year periods.

Manager tenure, is the length of time a manager has been running that particular fund. And this is important when looking at the past performance of any fund.

Mutual Funds NAV, this is the Net Asset Value, that is what that funds current price is to buy or sell.

The second part of this article will show you How to Choose the Right Mutual Funds.

Sam Montana © 04 December 2008

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