Mutual Funds for Beginners

what is a mutual fund what are the different types of mutual funds out there and what is the minimum amount of money you need to start investing in mutual funds answers to all of these questions and more coming up hello and welcome to practical personal finance where you get the information you need to understand and succeed with money today we'll be covering the basics of mutual funds and i'll be joined by andy panko andy is a certified financial planner and the owner of tenant financial in central new jersey he received his mba from rutgers university and he's been in the financial services industry for over 20 years when he's not busy helping his clients there's a good chance andy's tackling a new woodworking project or making video content for his youtube channel retirement planning demystified and now without any further delay here's my conversation with andy panko [Music] andy thank you so much for coming on the show today and for sharing your knowledge and expertise with all of us i know our topic today is mutual funds so let's start out with the most basic question of all what is a mutual fund so at a high level it's a pooled investment vehicle where instead of buying a single stock or a single bond you and hundreds if not thousands of other investors all take your money pull it into a big pot and there's a manager who oversees that pot that'll go then take all that money and invest it in a collection of stocks bonds or whatever most of us are familiar with the concept of buying stock in a single company why might purchasing a mutual fund instead be a better idea a few reasons basically it's the ease efficiency and cost effectiveness of getting diversification that's why i'd use a mutual fund so an example would be let's assume you only had a thousand dollars to invest and you wanted to buy some stocks well there's some stocks where one share alone costs more than a thousand dollars so you can't buy any of that stock let alone buying dozens or hundreds of individual stocks to get yourself a diversified portfolio of a whole collection of stocks so by taking your thousand dollars putting into a mutual fund again it's this pooled concept where you and hundreds or thousands of other people all put your however much money in so that this collective pot is now hundreds of millions if not billions of dollars so there's this huge bin of buying power that can go out and easily and efficiently buy dozens or hundreds or thousands of individual positions so you as a mutual fund owner own a pro-rated slice of that pool where your thousand dollars can now get you potentially thousands of underlying investments whereas you wouldn't possibly be able to buy those thousand investments by yourself with only that thousand dollar purchase i've heard you use the term diversification a few times now what is diversification and why is it important yeah diversification is extremely important it's basically the concept of not putting all of your eggs in one basket or two or three baskets or let's assume you own just one stock that stock can theoretically go to zero if the company becomes bankrupt or it ends up there's accounting fraud or something the share price can can literally go to zero in that case you lose 100 of your investment with diversification you own dozens or hundreds of stocks and even if one two or even a handful of those stocks goes bust and goes to zero it's virtually impossible for all dozen or 100 of those stocks to all go to zero so yes you may not make as much like a single stock can go up three four five ten times in value a big collection of stocks chances are it's not going to go up potentially that much but it's also virtually impossible for a diversified basket of dozens or hundreds of stocks to all go to zero that's an end of the world scenario if that happens we have bigger problems but assuming that doesn't happen diversification helps prevent extreme upside swings and also the extreme downside losses what type of people are mutual funds best suited for frankly mutual funds could be good for anybody again because it provides cheap easy and cost-effective diversification going back to that example it'd be really difficult for you even if you had hundreds of thousands of dollars it would be a lot of work to try to go pick dozens or hundreds of individual investments manage them you know buy and sell rebalance them to keep them in some sort of sensible collection of a portfolio you can just simply buy one mutual fund if you wanted to or a few but the point is you're only buying a limited number of funds that makes it significantly easier to administer and invest your portfolio as opposed to you doing the the picking of potentially hundreds of individual securities so for that reason really anybody can benefit from it whether you've got a thousand bucks or a few million dollars there's no good reason why mutual funds aren't going to work for someone in most cases what are the different types of mutual funds out there there's a few ways to classify and slice and dice them typically it's by security type or instrument type so there's mutual funds that invest in stocks there's mutual funds that invest in bonds there's other more granular forms of mutual fund you can pick not just stocks not just bonds for example some invest in commodities like gas or oil or wheat or something like that but generally speaking it's going to be stocks or bonds now within each of those you can further subdivide in numerous different ways so bonds you can have bonds issued by federal governments you can have bonds issued by corporations on the stock side you can have stock of small companies of medium-sized companies of large companies of u.s companies of international companies etc so it really depends what particular type of investment or exposure you're looking for that then dictates which type of mutual fund is best for you and your needs right right if i'm looking to invest some of my money in mutual funds i can imagine there must be thousands of choices so on the topic of determining what type of mutual fund is best for my needs how might i narrow down my choices yeah that's a good one part of it is the industry's fault for creating endless amounts of what's oftentimes virtually the same thing there's hundreds of different companies that create and sell mutual funds most the time there's not a lot of distinction or differentiation between them different companies can more or less offer the identical product just their own flavor of it with their own brand so it makes it really hard as a consumer to filter through all that and pick which company which specific fund is is the best for me where you would start is you need to figure out your general investment allocation how much exposure do you want to stocks how much exposure you want to bonds that's always the first step then from there you figure out the instruments that most efficiently get you that exposure whether it's mutual funds or individual stocks that's partly personal preference partly what your views are and whether or not you think you can do better picking your own investments as opposed to letting a mutual fund manager pick for you and then once you decide you know let's assume you do decide you want to go down the mutual fund route well then you have to figure out which company do i get from and that's partly driven by which particular strategy do you want if you just want something what's called passive where the fund just tries to replicate some sort of index some broad stock or bond index then fine then you know you want a passive fund and you go find there's dozens of companies that have passive funds if you want a particular strategy that tries to do something special or unique maybe that strategy is only offered by one or two particular companies so that then guides your hand to say okay i want or need to buy a fund from this company as opposed to the other hundreds of companies out there and then it comes down to also you know separate from strategy it's basically fees fees are important which we can touch on also the pedigree or history of the company there's lots of big fun companies out there we've all heard of there's also some you've never heard of i don't want to say there's companies that are fly-by-night companies but there's definitely smaller less established ones that generally speaking it's probably better to stay away from and go with the tried and true companies that have been around for decades and have you know massive amounts of funds and assets behind them now i heard you mentioned small companies and large companies being a differentiator between different types of mutual funds can you talk about some of the differences between large cap and small cap companies and how they fit into the conversation about mutual funds so cap stands for capitalization it's a fairly technical term but capitalization just essentially means company size so if you have a company that has 100 shares outstanding and each share is currently trading for ten dollars per share multiply the number of shares times share price and that's one thousand dollars so that company's capitalization would be one thousand dollars now small cap means companies that are small capitalization or small size large cap means companies that are large capitalization or size and then you have things in between mid cap or medium cap or whatever name you choose to give it now there's no i don't believe there's hard limits as to what defines small verse large generally speaking any company whose size or capitalization is under a billion or two billion dollars i believe is typically called small cap anything i believe 10 billion or larger in in capitalization is called large cap and then the mid caps are somewhere in between there's also at the extremes there's micro cap stocks which i think are generally a couple hundred million or smaller in size and then there's what's called mega cap things like you know the the behemoth names we've all heard of we use their products their capitalizations their hundreds of millions if um their capitalizations are well into the hundreds of billions if not a trillion dollars there have been some companies i don't know if there are now but there were some companies who capitalizations hit one trillion dollars so those would be the mega cap names what about the differences between mutual funds when it comes to what brokerage i might be using so there's two companies to keep in mind when when you invest in mutual funds there's the fund company that actually creates and manages the fund and then there's the company or broker a custodian through which you own the fund now this gets into how you buy mutual funds and there's two ways to go about it one is you can buy direct from the fun company that creates and manages the fund in which case that's the only party involved it's you and that company when you have a thousand dollars you put into the fund you write a check or send a bank ach transfer for a thousand dollars you subscribe to the fund and they they tell you okay you now have a thousand dollars worth of ownership in this big pot of money which is the fund that's option one option two is you can buy a fund through a traditional broker the same brokers that you can buy stocks and bonds through in that case you have the broker custodian that you have your account with you can buy funds through that account so you may have a fund managed and issued by fund company abc that you own through broker xyz so in that case there's two parties involved you're still ultimately invested in fund abc but you indirectly hold it through your account at broker xyz what's the minimum amount of money i need to start investing in mutual funds that really depends on the fun company and the particular fund that you're looking at there are some mutual funds that have zero minimum so yes you can write a check for 25 and buy into the fund there's other funds that have 500 thousand dollars some are three or five thousand dollar minimums and then there's other some funds have institutional classes or shares of the fund that are meant for larger bigger dollar amount investments they often have lower fees associated with them but they have higher minimums in which cases it may be tens of thousands of dollars if not a hundred thousand dollars plus to invest in those particular uh classes of funds but generally it's figure a few hundred dollars maybe a thousand bucks for the for the typical minimum uh mutual fund are there any fees involved when it comes to buying and selling mutual funds so the actual purchase or sale of funds could have two fees involved potentially one is go back to the example of where you buy fund abc through a brokerage account at broker xyz in that case the broker you're buying through may charge a fee just like some brokers charge fees to buy and sell stocks or bonds that fee could be anywhere from zero perhaps up to fifty dollars or so per transaction per purchase or sale of a mutual fund if you buy without the broker and you and you invest directly by just sending a check to fund manager abc there's usually no trade specific fees that there's there's no 20 fee to buy and sell but there are some funds that have what's called a load a load is just a fancy word for a commission sometimes you have to pay a commission to buy into the fund sometimes you pay a commission on your way out of the fund when you eventually sell it now 20 years ago most funds had some sort of load to buy or sell into or out of the fund now thankfully most funds don't there are however still some funds that have a load or commission associated with them and it can be upwards of five percent or so so for example if you have an upfront load to buy into a fund and it's five percent if you have a hundred dollars you want to invest in the fund only 95 actually goes into the fund as an investment the other five is paid to the fund company as that five percent uh sales commissioner load i would say this day and age is really not many funds with loads where the strategy is so unique or the fund is so special that it's worth paying that load or commission to buy or sell the fund so generally speaking stay away from funds with loads and go to what's called no load funds which just simply means there's no commission to buy or sell into or out of that fund i've also heard the term expense ratios in relation to mutual funds what should i know about expense ratios so there's costs associated with creating with running a mutual fund so if you think about it you and hundreds of people all pool your money into this pot someone's got to oversee that pot there's the operational aspects of taking checks in sending checks out when people want to redeem out of the fund there's a day-to-day management of the fund there's people who pick the individual stocks and bonds in the fund all those things cost money so the expense ratio is what's used to basically pay for those expenses now it's it's a little i don't want to call it sneaky the expense ratio isn't something you explicitly pay directly it's baked into the fund and the value of your holding so for example if a fund has an expense ratio of one percent that means each year the fund companies is essentially taking one percent of the value out of your account and using it to compensate themselves for the fees and expenses associated with running the fund so that's the expense ratio it's always quoted as a percentage uh and expense ratios range from summer zero or close to it on the high end is one percent or so some funds are even higher which is absolutely insane but generally speaking expense ratios of about half percent or so are common less than that is relatively low higher than that's fairly high is there anything else you think our audience absolutely needs to know about mutual funds i think it's important to know that mutual funds make the investment management process exceptionally streamlined easy cost effective and efficient not to say you can't put together a good portfolio by individually picking a bunch of stocks and bonds yourself but why would you it's so much easier and more effective to just buy a mutual fund you're basically outsourcing the process of someone else doing all the individual picking and administration of the fund you just buy into it and kind of sit back and relax most people can get away with anywhere from one to four funds and that's all they really need for their investment management because if you think about it a fund could have hundreds if not thousands of underlying positions you would never be able to practically manage hundreds or thousands of individual positions yourself yet by buying it to one fund that's the beauty of it you get exposure to a whole world of different investments that you can't possibly piece together on your own andy once again thank you so much for taking the time to come on the show today and share some of your knowledge and expertise when it comes to the topic of mutual funds if anyone would like to learn more from you where can they find you you can check out my website ten in financial that's t as in thomas e n o n financial dot com i also have a youtube channel retirement planning demystified the content is focused mainly on those near or in retirement but i do occasionally do some more generic finance and investing and tax videos there so definitely check that out and i have a great facebook group taxes in retirement again focused typically on uh content for people in or near retirement specifically with the angle on the tax planning and minimization aspects of financial planning [Music] i want to thank my friend andy panko for taking the time to answer my questions about mutual funds do you have any other questions that we didn't cover let me know in the comments if you enjoyed this video click right here to check out andy's channel retirement planning demystified and for more great content just like this click right here to subscribe to practical personal finance as always thanks for watching i'm andrew scheer and i'll see you next time

Channel: Practical Personal Finance

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Keywords: practical personal finance, practical pf, mutual funds, investing, finance, diversification, retirement, portfolio, investing education, mutual funds india, mutual funds for beginners, mutual funds explained, mutual fund what is, mutual fund trading 101, mutual fund intro to trading, mutual fund investing, mutual fund markets, Mutual funds, what is a mutual fund and how does it work, mutual funds to invest in, mutual funds investment, mutual fund investment, What Is A Mutual Fund

Id: dhOLnHDmijs

Length: 19min 3sec (1143 seconds)

Published: Thu Feb 25 2021