How to Invest in Mutual Funds

Mutual funds are professionally managed portfolios that invest in a variety of stocks, bonds and other assets. So investing in mutual funds takes the time and expertise out of prudently picking your own stocks and other investments.

How do mutual funds work?

Asset management companies pool money from several investors and use it to buy stocks or other investments within a mutual fund. As an investor, you gain based on the positive performance of the investments in the mutual fund and the proportion of shares you own.

The price of a mutual fund share is known as its net asset value (NAV). It reflects the combined price of the securities in the fund and is typically set at the end of the trading day. So if the price of your mutual fund shares increases, you can sell these for a profit.

But some mutual funds also make regular payments to investors in the form of dividends from stocks or interest from bonds held in the mutual fund.

Because a mutual fund pools money from different investors, you may not need to invest a large sum in one share of a major company’s stock. In fact, many mutual funds invest in the stocks of leading companies and require relatively small minimum investments.

Each mutual fund has a specific objective like long-term growth. Its managers use their expertise to carefully pick assets they believe will help the fund meet those goals. They continually monitor these funds and add or remove assets as they see fit based on market conditions.

Types of mutual funds

There are several types of mutual funds. These are typically categorized based on the type of assets they invest in such as stocks of large companies or investment strategies such as growth-oriented. In some cases, it’s a combination of the two. Here’s a quick comparison before we go into detail on each.

Fund type	What it invests in	Risk level
Stock (equity) funds	Shares of individual companies	Medium to high
Bond (fixed-income) funds	Corporate and government bonds	Low to medium
Balanced funds	A mix of stocks, bonds and other assets	Medium
Index funds	Stocks that track a market index like the S&P 500	Medium
Money market funds	Short-term, low-risk securities like Treasury bills	Low

Stock (equity) funds

As you guessed, these mutual funds invest primarily in stocks. There are subcategories of stock funds, typically based on the size of the companies they invest in and the investment strategy.

• Large-cap mutual funds
  These mutual funds invest in companies with market capitalizations of more than $10 billion. Market cap is taken by multiplying the price of a single share of a company’s stock by the number of shares outstanding.
• Small-cap mutual funds
  These mutual funds invest in companies with market caps between $300 million to $2 billion.
• Mid-cap mutual funds
  These funds invest in companies with market caps that fill the gap between large-and-mid caps.

Strategy mutual funds

In some cases, stock funds are named after the size of the companies they invest in and the investment strategy employed by the fund managers. An example would be a large-cap value fund. These mutual funds invest in large companies that are in fundamentally good financial shape but may be undervalued in terms of share price. Meanwhile, growth funds invest in companies that have proven track records and are expected to keep growing.

Bond (fixed-income) fund

These funds invest in assets that pay interest. These can include corporate bonds, government bonds and more.

Balanced funds

These invest in different types of assets such as stocks, bonds and real estate. Many balanced funds are named after the level of risk they take on based on the types of assets they invest in. A conservative fund would invest mostly in safer securities like bonds. An aggressive fund would invest mostly in growth-oriented assets like stocks.

Index funds

These mutual funds invest in stocks within a particular index such as the S&P 500, which contains some of the biggest companies in the country. To minimize risk, fund managers attempt to match the performance of the corresponding index rather than beat it. That’s the strategy employed by actively managed funds. Index funds can be seen as passively managed funds.

Money market funds

These invest in generally safe securities like Treasury Bills. It’s a good place to park your money for safety because you’re not likely to lose it. But money market funds generally gain small returns similar to a typical savings account.

What’s the difference between a closed-end and open-end fund?

A closed-end fund sells a fixed number of shares through an initial public offering. An open-end fund sells shares directly to investors. This means you can buy an open-end fund through a brokerage account.

How to invest in mutual funds in 4 steps

Investing in mutual funds is as simple as buying any other stock. You can do so once each trading day.

1. Decide what kind of fund you want to invest in

As covered above, mutual funds don’t differ only by their asset holdings — they differ in how they’re managed. There are active and passive mutual funds. Active funds are managed actively by a fund manager with the goal of making higher returns than the broader stock market.

Passive funds typically track a particular index — say, the S&P 500 — and the return mimics the moves of the index. Active mutual funds typically have a higher annual fee than passive funds because of the way they’re managed.

2. Determine your budget

Unlike exchange-traded funds (ETFs) where you can buy with any amount of money you want, mutual funds have minimum investment requirements. Typically this is between $500 and $5,000. You may find some funds for $100 and some without any minimums.

Another factor to consider is how many funds you want to invest in because the amounts can easily add up. Once you’ve set up your budget, find the right brokerage platform.

3. Select a brokerage platform

Look for larger and well-established brokerage firms. Interactive Brokers offers access to more than 50,000 mutual funds worldwide, including over 20,000 with no transaction fee. Robinhood still doesn’t offer mutual funds, though SoFi added a lineup of no-transaction-fee mutual funds to its platform. Make sure you compare the fees and the mutual fund minimum requirements to find the right brokerage.

4. Buy the mutual funds

Once you select a brokerage platform, proceed to open an account then invest in mutual funds:

1. Look up the mutual fund’s ticker symbol or manually search for a fund.
2. Decide how many shares you want to buy.
3. Review your order and submit.

Mutual funds vs. ETFs

Mutual funds and exchange-traded funds (ETFs) both let you buy a professionally assembled basket of investments in a single purchase, but they differ in a few important ways.

• Trading: Mutual funds trade once a day after the market closes, at their NAV. ETFs trade throughout the day on an exchange, like a stock, so the price can move with the market.
• Minimum investment: Mutual funds often require a minimum investment of $100 to $5,000 or more. Most ETFs can be bought for the price of a single share, and some brokers now offer fractional ETF shares for even less.
• Fees: Mutual funds — especially actively managed ones — can carry sales loads and higher expense ratios. ETFs are typically passively managed and tend to have lower expense ratios and no sales loads.
• Taxes: ETFs are generally more tax-efficient than mutual funds because of how their shares are created and redeemed, which tends to trigger fewer taxable capital gains distributions.

Neither is universally “better.” Mutual funds can make sense if you want active management or access to a specific strategy that isn’t available as an ETF, while ETFs are usually the lower-cost, more flexible option for passive, buy-and-hold investing.

Benefits of mutual funds

Mutual funds may be great for new investors who want access to a professionally managed portfolio. Here are some of the benefits.

• Instant diversification: If you put all your money in one stock and that stock plummets, you’ll take a serious hit. But if one stock in a mutual fund goes down, it can be offset by the positive performance of the other stocks in it. This is the benefit of diversification. You’re not putting all your eggs in one basket when you invest in mutual funds.
• Pooled investment vehicle: Mutual funds pool money from several investors to buy securities. That can bring down the costs of creating your own mutual fund by purchasing shares of several different stocks.
• Professionally managed: Mutual funds are run by experts from large investment-management firms.

What are the drawbacks of mutual funds?

Like any investment, mutual funds involve risks.

• Fees: Mutual fund fees will vary across funds. Some common ones to look out for are:
  • Expense ratio: This is the fee that investment companies collect for running the mutual fund. It’s expressed as a percentage. So a proportional expense ratio would typically be deducted from your account based on the number of shares you own.
  • Sales loads: These are commissions that brokers collect for selling mutual fund shares to you. These can be triggered when you buy shares of a mutual fund or after you sell your shares before a specific time frame. But look for no-load funds as many funds have done away with these fees.
  • 12b-1 fees: These are marketing, distribution and shareholder-service fees collected by money managers. Because they’re operational costs, they’re usually factored into the fund’s expense ratio. By FINRA rule, total 12b-1 fees can’t exceed 1% of a fund’s net assets a year, made up of a distribution fee capped at 0.75% and a shareholder-service fee capped at 0.25%.⁽¹⁾,
• Potential for mismanagement: Fund managers may engage in unnecessary trading and excessive replacement of assets in the fund, which can raise risk.
• Taxes: Because of gains and turnover within a fund, investors typically receive distributions from the fund, which are considered capital gains. So you’ll owe capital gains taxes.

17% of Americans use a mutual fund

Which method(s) are you using to invest in stocks?

About 17% of Americans say they use a mutual fund as their means for getting exposure to stocks, only behind investing in individual stocks at 18%.

Bottom line

Mutual funds are professionally managed portfolios that hold a variety of assets, such as stocks, bonds, commodities and currencies, and can be either actively managed or built to passively track an index. Minimum investment requirements typically range from $100 to $5,000 depending on the fund, and once you’ve opened and funded a brokerage account, you can buy mutual funds online the same way you’d buy a stock or ETF.

Frequently asked questions

• Can you buy mutual funds online?

  Yes. Most major brokerages let you open an account and buy mutual funds online, the same way you'd buy a stock or ETF. You'll typically need to fund your account first, then search for the fund by its ticker symbol or name.

• How much money do I need to invest in mutual funds?

  It depends on the fund. Many mutual funds set a minimum investment between $100 and $5,000, though some have no minimum at all. Check a fund's minimum before you decide which brokerage and fund to use.

• Are mutual funds good for beginners?

  Mutual funds can be a good fit for beginners because a professional manager makes the investment decisions and your money is automatically spread across many holdings. That said, beginners should still compare fees and minimums across funds before investing.

• What's the difference between mutual funds and ETFs?

  Mutual funds trade once a day at their net asset value and often carry higher fees and minimums. ETFs trade throughout the day like a stock and tend to have lower fees, no minimums beyond the price of a share and better tax efficiency.

• How are mutual funds taxed?

  When a mutual fund sells assets for a gain or pays out dividends and interest, it typically passes those distributions on to investors, who owe capital gains or income tax on them — even if you didn't sell your own shares that year.

• Can you lose money in a mutual fund?

  Yes. Mutual funds aren't guaranteed or insured, and their value moves with the underlying stocks, bonds or other assets they hold. Diversification can reduce risk, but it doesn't eliminate the possibility of a loss.