How to make money 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 fall into one of four categories based on where they invest money (your money). They are called: equity (stock), bonds, money market and balanced funds. In all of the above, you open an account, deposit money, and it buys you shares. You make money by investing based on the number of shares you own. The same is true if you lose money investing.
Let’s start with the most popular and riskiest category called EQUITY FUNDS, which invest in shares, also called “stocks”. Why invest money here? Growth is the primary objective and dividend income is secondary. You make money by investing here when the share price goes up and from the dividends. You lose money when the stock price falls. Dividends come from the shares in the fund’s portfolio and are passed on to you. They (like all dividends) belong to you. The main appeal of equity funds: the potential for high returns.
BOND FUNDS have one primary goal: higher income in the form of dividends. They are also called INCOME FUNDS and are generally safer than equity funds. You invest here to get higher dividends than you can get elsewhere. Dividends come from interest earned on the fund’s bond portfolio. You can also make money by investing when the share price goes up; and lose money when the stock price falls. Usually, the price swings are much smaller than in the stock or share category.
BALANCED FUNDS are a happy medium between the above two because they invest in both stocks and bonds. So you make money from both rising stock prices and dividends, and lose money investing when stock prices fall. Here you have moderate risk.
MONEY MARKET FUNDS are a safe alternative, and you make money investing in them in only one way: dividends. They invest money and earn interest in quality short-term (money market) IOUs. They pass this interest on to you in the form of dividends. The share price is pegged at $1 and does not fluctuate. It is very rare for investors to lose money investing here.
Most people invest in mutual funds as long-term investments. So, in most cases, they simply allow the fund company to reinvest all dividends (and other distributions) to buy more shares. Distributions (such as capital gains from the sale of shares) are a bit technical. Don’t worry – you’ll get your share when they come. You will also receive periodic reports on your account activity.
We said at the beginning that there are basically two ways to make money and two ways to lose money by investing in mutual funds. What is another way to lose money? Let me give you an example, and as a former financial planner I have seen this happen time and time again. Joe Blow decided to invest 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 total of $19,000.
The stock market showed modest growth that year. How did he lose money investing? Answer: The $1,000 came from paying sales called “downloads.” About $300 went toward annual fund expenses and another $300 toward additional fees. Joe claims he knew nothing about these fees and charges.
You don’t have to pay big bucks when you invest in mutual funds. If Joe went with no-load funds, he could invest for a total of about $200 a year in expenses. You can make money by investing in mutual funds as a long-term investment. Just don’t work against yourself by losing money to high fees and charges.