Even if you don’t really understand stocks and bonds and the markets they trade-in, you and other beginners can make money investing in mutual funds once you get a handle on the mutual fund’s universe. Here we take the mystery out of investing for beginners.
News flash: Tens of millions of Americans make money investing in mutual funds without knowing what they are doing. Caution: They also lose money unnecessarily, and they are not investing as beginners because they have been doing it for years. Let’s look at what you really need to know to make money investing on a more consistent basis while avoiding serious losses.
Mutual funds were created and promoted as the average investor’s vehicle for investing money in stocks and bonds. That’s just what they are – packages of investments managed for investors by professional money managers. They make investing for beginners simple. You open an account and put your money down with instructions on how much to invest in which funds. Example: You send in $10,000 to buy shares of ABC Stock Fund. You will soon own shares in that fund and own a tiny part of an extensive portfolio of stocks. The number of shares you will own will depend on the share price when your purchase order is processed.
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Whether or not you make money investing in mutual funds without taking much risk depends on which funds you invest money in and how you go about it. There are basically three traditional fund alternatives: stock (diversified), bond, and money market funds. You should invest in ALL THREE TYPES if your goal is to make money investing in mutual funds consistently. You also need to understand asset allocation, so you can tailor your total mutual fund portfolio to fit your risk profile. And remember, investing for beginners need not be difficult.
Diversified stock funds are the three riskiest, and they are your growth engine for earning higher returns. They invest your money in a broad spectrum of stocks representing several different industries. This makes investing for beginners simple compared to picking your own stocks. You make money investing here primarily through price appreciation (the fund share price going up) and through dividends. The major risk: share prices fluctuate and can fall significantly when the stock market falls. One year you can make 20%, 30%, or more, and you can also lose that much. Over the long term, investors have averaged about 10% a year. Notice I said LONG TERM.
Bond funds invest your money in bonds, which are debt securities that pay interest. Their primary objective is not growth but rather to earn higher interest for investors than they could earn from safe investments like bank CDs. Traditionally, you make money investing in these mutual funds primarily through the dividends they pay you from the interest they earn. Normally they pay considerably higher dividends than stock funds do, but similar to stock funds, their share price fluctuates (usually much less). You can profit from higher share prices, but you can also lose money here. They are considered safer investments than stock funds, but bond funds are not necessarily safe investments.
Money market funds invest your money in high-quality short-term debt instruments (IOUs) and pay current interest rates in the form of dividends. Unlike the other two mutual funds, their share price is pegged at $1 and does not fluctuate by design. As interest rates go up, the dividend increases, and as rates fall, so does the dividend. You make money investing in these mutual funds only through the dividends paid. These mutual funds are considered safe investments and can be used as a cash reserve awaiting bigger opportunities.
To make money investing in mutual funds without worrying your head off, you should invest in all three to have a balanced investment portfolio. Here’s what I mean by balance and why it is so important to investing for beginners. Holding either stock or bond funds involves the risk of losing money. If you invest in both, this will lower your overall risk. Reason: oftentimes, losses in one are offset by gains in the other. Money market funds add flexibility and a cushion of risk to your overall portfolio of mutual funds. The more safety you want, the more you allocate to money market funds.
An example of investing for beginners follows. You invest $10,000 equally allocated to the three basic fund types. A couple of years later, you see that the stock fund is worth quite a bit more than the other two. The good news is that stocks performed very well. The bad news is that a major decline in stock prices could wipe out your profits and more. To keep things in balance, rebalance once a year so that you are back to equal amounts in each fund. This is very important if you want to make money investing in mutual funds consistently without unpleasant surprises every few years.