Ultimate Guide to Mutual Funds: Everything You Need to Know

Mutual funds have become increasingly popular among investors looking to diversify their portfolios and achieve long-term financial goals. In this ultimate guide, we’ll cover everything you need to know, from the basics to advanced strategies.

What Are Mutual Funds and How Do They Work?

Mutual funds provide investors with a convenient way to own a diversified portfolio of stocks, bonds, or other securities through a single investment.

A mutual fund pools money from many investors and invests those assets according to a specific investment objective or strategy. Depending on the fund, the portfolio may be actively managed by a professional investment team or passively managed to track a market index.

Mutual funds can play an important role in a diversified portfolio, but not all funds are created equal. Costs, investment strategy, risk, tax implications, historical performance, and how a fund complements the rest of your portfolio should all be considered before investing.

Common Types of Mutual Funds

Mutual funds are available across nearly every major asset class and investment style.

Equity Funds

Invest primarily in stocks and generally seek long-term capital appreciation. Equity funds may focus on U.S. companies, international markets, specific company sizes, investment styles, or other market segments.

Bond Funds

Invest primarily in government, municipal, corporate, or other fixed-income securities. Bond funds may be used for income, diversification, or potentially reducing overall portfolio volatility. However, bond funds can still lose value due to changes in interest rates, credit conditions, and market prices.

Index Funds

Seek to track the performance of a particular market index rather than attempting to outperform it. Because they generally require less active portfolio management, index mutual funds often have lower operating expenses than actively managed funds.

Sector and Thematic Funds

Concentrate investments within a particular industry, sector, or investment theme, such as technology, healthcare, financial services, energy, or infrastructure. These funds can provide targeted exposure but may carry greater concentration risk.

Balanced and Asset Allocation Funds

Invest across multiple asset classes, commonly including stocks and bonds, with the goal of balancing growth, income, and risk within a single investment.

Potential Benefits of Mutual Funds

Diversification

A single mutual fund may own dozens or even hundreds of individual securities. This can help reduce the impact that any one company or investment has on an overall portfolio. Diversification, however, does not eliminate investment risk or guarantee against loss.

Professional Management

Actively managed mutual funds employ investment professionals who research securities, construct portfolios, and make ongoing investment decisions on behalf of shareholders.

Accessibility

Mutual funds can make it relatively simple for investors to obtain broad market exposure without selecting and managing numerous individual investments themselves.

Liquidity

Shares of most mutual funds can generally be purchased or redeemed on any business day. Unlike stocks and exchange-traded funds, however, mutual fund transactions typically occur at the fund’s net asset value, calculated after the market closes.

Broad Investment Choices

Investors can choose among thousands of mutual funds covering different asset classes, markets, investment styles, risk levels, and objectives.

What Should Investors Consider Before Buying a Mutual Fund?

The fund with the highest recent return is not necessarily the fund that is best suited for your portfolio.

Important factors to evaluate include:

Investment Objective and Strategy

Understand what the fund owns, how it invests, and the role it is designed to serve within your overall financial plan.

Risk

Different mutual funds can have dramatically different levels of risk. Investors should consider market risk, interest-rate risk, credit risk, concentration risk, currency risk, and other risks associated with the fund’s investments.

Expenses

Mutual fund expenses reduce the return ultimately received by shareholders. These may include management expenses and other operating costs reflected in the fund’s expense ratio.

Certain mutual funds may also have sales charges, commonly referred to as loads, or other distribution and servicing expenses. Investors should understand the total cost of owning a fund before investing.

Performance and Risk-Adjusted Results

Historical performance can provide useful information, but it should not be evaluated in isolation. Investors should consider how the fund performed through different market environments, how much risk was taken to generate those returns, and how results compare with an appropriate benchmark and similar investments.

Past performance does not guarantee future results.

Portfolio Overlap

Owning several mutual funds does not necessarily mean your portfolio is well diversified. Different funds may own many of the same companies or securities, unintentionally creating concentrated exposure.

Taxes

Tax considerations can be particularly important when mutual funds are held in taxable accounts.

Mutual funds may distribute dividends, interest, and realized capital gains to shareholders. An investor can potentially owe taxes on a capital-gains distribution even if they did not personally sell shares of the fund and, in some circumstances, even if they purchased the fund relatively recently.

For investors concerned about taxes, the potential tax consequences of a mutual fund should therefore be evaluated along with its investment performance.

Mutual Funds vs. ETFs

Mutual funds and exchange-traded funds both allow investors to obtain diversified exposure to a portfolio of securities, but there are important differences.

Mutual funds generally transact once per day at their calculated net asset value, while ETFs trade throughout the trading day like stocks. ETFs can also offer lower expenses and greater tax efficiency in certain circumstances, although these advantages vary by investment and should not be assumed in every case.

The appropriate structure depends on the investor, the strategy being implemented, the type of account, costs, taxes, liquidity needs, and the role the investment is expected to play within the portfolio.

Rather than choosing an investment simply because it is structured as a mutual fund or ETF, we believe investors should focus on what they own, why they own it, what they are paying, how much risk they are taking, and how the investment fits within their overall financial plan.

Building a Portfolio Around Your Goals

Selecting investments should involve more than identifying funds that have recently performed well.

At Hennion & Walsh, we help investors evaluate their existing investments and determine whether their portfolio remains aligned with their objectives, risk tolerance, income needs, time horizon, and tax situation.

Depending on your circumstances, an appropriate portfolio may incorporate mutual funds, exchange-traded funds, individual stocks, bonds, cash alternatives, or other investments. The goal is not simply to own more investments, but to create a coordinated portfolio in which every investment serves a purpose.

All investments involve risk, including loss of principal. Past performance does not guarantee future returns. Diversification and asset allocation do not ensure a profit or protect against loss. Past performance does not guarantee future results. Investors should consider a mutual fund’s investment objectives, risks, charges, and expenses carefully before investing. This and other information is contained in the fund’s prospectus.