Pricing An Investment In Order To Earn A Return Finance Mutual Fund Investing 101: How You Make Money

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Mutual Fund Investing 101: How You Make Money

How to earn money by investing in mutual funds? There are basically two ways to make money and two ways to lose money investing in mutual funds. Let’s get down to the basics.

There are thousands of funds to choose from and the vast majority of them will fall into one of four categories based on where they invest money (your money). They are called: equity (stocks), bonds, money market, and balanced funds. In all of the above you open an account, invest money, and it buys you shares. You invest money based on the number of shares you own. The same happens if you lose money investing.

Let’s start with the most popular and risky category called equity funds that invest money in stocks called “equities”. Why invest money here? The primary objective is growth, with dividend income as a secondary objective. You earn money by investing here as the share price goes up and from dividends. You lose money when the share price falls. Dividends come from the stocks in the fund portfolio and are transferred to you. They (like all dividends) are yours to keep. Primary attraction of equity funds: Potential for high returns.

Bond funds have one primary objective: high income in the form of dividends. They are also called income funds, and are generally safer than the equity variety. You invest money here to earn higher dividends than you can get anywhere else. Dividends come from interest earned on the fund’s bond portfolio. You can also invest money when the share price rises; And lose money when share prices fall. Generally, there is much less price volatility than you would find in the equity or stock category.

Balanced funds are a happy medium between the above two, as they invest money in both stocks and bonds. So you make money from both rising share prices and dividends, and lose money invested when share prices fall. Here you have moderate risk.

Money market funds are a safe option and you only make money by investing in them in one way: dividends. They invest money and earn interest in high-quality, short-term IOUs (in the money market). This interest they pass on to you as a dividend. The share price is pegged at $1 and does not fluctuate. Very rarely investors lose money invested here.

Most people invest money in mutual funds as a long-term investment. So, in most cases they allow the fund company to reinvest all dividends (and other distributions) to buy more shares. Distributions (such as capital gains from the sale of stock) are a bit more technical. Don’t worry – if you have them coming, you’ll get your share. And you will also receive periodic statements showing the activity in your account.

At the beginning we said that there are basically two ways to make money and two ways to lose money investing in mutual funds. What is the second way you can lose money? Let me give you an example, and as a former financial planner I’ve seen it happen time and time again. Joe Blow decided to invest money in mutual funds through a “financial planner” (not me). He put $20,000 into a stock fund, and about a year later he looked at his last statement and it showed a net worth of $19,000.

That year saw a modest rise in the stock market. How did he lose the money he invested? Answer: $1000 came from the top to pay for a sales charge called a “load.” About $300 went to annual fund expenses, and another $300 to additional fees. Joe claims he knew nothing about these fees and charges.

There is no need to pay huge amounts while investing money in mutual funds. If Joe had gone with a no-load fund, he could have invested a total of about $200 a year in expenses. You can invest money in mutual funds as a long-term investment. Don’t work against yourself by simply losing money on high fees and charges.

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