Spreading your Risk with Mutual Funds

Interest rates, although they are creeping up a bit, are still at all-time lows. While this may be great if you are buying a home, it's not ideal for those with money to invest. Simply keeping your money in the bank or buying a certificate of deposit will give you very low returns. Historically, the stock market--especially when taken from a long-term investment perspective--has delivered above-average returns. But investing in the stock market requires a lot of careful study, and there is an element of risk involved, so it's not an investment vehicle for everyone.

If you're not stock market savvy, you can still get potentially better-than-bank-interest returns through mutual funds investments. A mutual fund is an investment whereby small investors pool their money, which is then controlled by a professional funds manager who makes investment decisions. Even though your individual share of the fund may be as little as just a few hundred dollars, the fund itself usually totals several million. This allows the fund to minimize trading costs, and diversify holdings in such a way that a small, individual stockholder could not. The ability to spread the risk by investing in several different holdings keeps potential loss to a minimum.

Mutual funds have different goals. A conservative mutual fund may be best suited for retirement savings, and will invest generally in blue chip, very solid stocks. High-yield mutual funds will invest in riskier holdings that have the potential for greater payoff. There is often a management fee, or "load," involved, so consider these fees when deciding on a fund. No-load funds are available as well, but in some cases, a fee-based fund may well be worth the extra expense if it has a good track record of above-average returns. In addition to the fees, determine the management/expense ratio. This is the ratio of management expenses as a percentage of the total assets. Different types of funds will experience different ratios; for example, an index fund will likely carry a very low ratio. A more actively managed, high-risk fund will require more oversight, and will therefore carry a higher ratio.

Another advantage to the small investor is that mutual funds tend to be very liquid--that is, you can take your money out when you need it. In most cases, you will be taxed on the capital gains. 

Not all mutual funds are stock market-based. Money market funds invest holdings in corporate and government debt, such as bonds, treasury bills or corporate paper. These money market funds offer the lowest risk, but also deliver the lowest return. However, return is still likely to be higher than placing your money in a passbook savings account. Other types of funds include fixed income funds, the goal of which is to provide a regular, steady income to holders. These funds invest in things like bonds and mortgage instruments that pay a regular return. Other types of specialty funds include index funds, which are tied to a composite index, and balanced funds, which invest in a broad range of vehicles that include stocks, bonds, and money market securities.

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