Tips on Understanding Mutual Funds
Mutual Funds, including those sold at banks, are very different from fixed-rate investments such as CDs. A CD buyer is guaranteed a specific rate of return by a certain date. In contrast, mutual fund prices can go up or down every day and you may lose your principal. Mutual funds (including money market mutual funds) sold by banks are not insured by the federal government. Money market mutual funds must not be confused with interest bearing “money market accounts,” which are bank deposits insured by the FDIC. Advertising brochures sometimes blur the line between a bank’s insured and uninsured products. Be sure you know which type of “Money Market” you're considering.
Always comparison-shop for mutual funds. Look “under the hood” of any mutual fund you're considering. Read and understand the fund’s prospectus. If you ask, a “Statement of Additional Information” will also be provided.
Ask for clarification of unfamiliar terms and abbreviations. An investment professional who is unwilling to take the time to answer your questions is one you probably don't want to entrust with your investment future.
Make sure that you know all fees and charges associated with your mutual fund.
- Front-end loads charge a percentage fee when you purchase the fund
- Back-end loads charge a percentage fee when you sell your fund
- No-load funds don't charge a fee when you buy or sell, but do charge a management fee.
Be aware of “breakpoint selling.” Most mutual funds reduce the sales charge, or load, after a certain dollar amount is invested or number of shares are bought. The point at which this happens is called the “breakpoint.” Ask your investment professional what the breakpoint is of the fund you're considering. In your prospectus, this information is found under the heading “Sales Charge.”
Some brokerage firms offer mutual funds and other investments that are sponsored by the firms themselves. These “proprietary products” are the property of the issuing firms and may not be sold by other firms or transferred into accounts at other firms. Often they carry a higher sales charge than other “outside” mutual funds. They may be recognized by their names, which often include the firm's name, such as “XYZ Brokerage Global Income Fund.” Ask your investment professional why a proprietary product is recommended over an outside fund with the same investment philosophy or performance. Before making a decision, ask for information on a variety of funds, both proprietary and non-proprietary, that meet your investment objectives.
Main Types of Mutual Funds
Stock funds typically offer the highest returns, but also involve more risk than money market or bond funds. Stock funds vary in purpose as well. Some stock funds focus their portfolio of stocks in a particular industry segment, such as technology or healthcare, or the portfolio may be designed to generate a particular financial outcome, such as growth or income.
Bond funds may have higher risks than money market funds, but also seek to pay higher yields. There are many different types of bonds, so funds of this type can vary dramatically in both risks and rewards. Typically, bond funds are suitable for those seeking income and preservation of capital. Have your broker explain the inverse relation of the price of bond prices to interest rates because this makes a big difference should you need to cash out your investment.
Money Market Funds
Compared to other mutual funds, money market funds have relatively low risks. Money market funds are limited by law to high quality, short-term investments. The money market fund pays a fluctuating interest rate on your funds. They look much like a checking account, but they're an investment in a pool of securities, and like all investments, losses are possible.