How To Invest Mutual Funds In The 21st Century
Because there are thousands and tens of thousands of funds it is rather dizzying to try to compare them all against each other. The way most people invest now is to use computerized tools like a mutual fund screener from Yahoo or Morningstar.
The most important considerations people worry about when they compare mutual funds are the following things: the risk or volatility, fee structure, past performance and the management team in charge of the fund, and the capitalization. These factors are the first things to learn how to invest mutual funds.
Past Performance
Buying mutual funds demands an understanding of the term “past performance”. The past performance is essentially the rates of return over years past that shows how “good” a fund is relative to others of the same class or an index fund. Each year one can calculate how much a fund has returned based on a hypothetical value of a share at the beginning of the year versus the value at the end of the year. There are a few caveats to this measurement. For example an investment that rises 50% in one year from $100 to $150 per share, but falls 50% the next year from $150 to $75, does not experience a total return of 0% but rather -25%!
Random Walks
The past performance is often given as an average rate of return over many years but hides the fact that all financial products fluctuate in value. The book “A Random Walk Down Wall Street” sums up this concept succinctly: stock market values seem to fluctuate up and down and have statistical properties akin to a mathematical construct known as a random walk. Only its average value seems to rise slowly as companies in general grow and become more productive. The magnitude of fluctuations is summarized in a measure known as the beta. These are subtleties when learning how to invest mutual funds.
Choosing A Brokerage
Before buying mutual funds an investor must open an account with a brokerage that offers the product. For example, one opens an account with Vanguard (site at vanguard.com) by depositing a minimum of $1000. After the account is opened, the client selects one of the many funds and purchases with some amount of money in the account. After about a day the transaction will go through, showing up as a debit from the account and a credit in terms of the fund shares.
Tracking Performance
After buying mutual funds an investor wants to track the performance of the fund. This made possible by the brokerage software that tracks how much money continues to go into the fund (automatic investments from a linked bank account) as well as appreciation in value due to movements in the broader stock market.