How Does Mutual Fund Investing Work

Continuing the series of posts on different aspects of finance to help provide the basic financial background needed to be successful financially in life, today we turn to the subject of mutual funds.  If you have not watched CNBC, read a book on investing, or picked up a copy of Money magazine or The Wall Street Journal, you’ve probably still heard of mutual funds but know little about them.  This is really a shame since mutual funds are an easy way to invest and belong in every household – not just those of the wealthy.  Let’s get into some of the basics and then talk about how you can get started in mutual fund investing.

What is a mutual fund?

A mutual fund is a way to invest where many people pool their money together to invest as a group.  For example, 10,000 people may get together and each put in $5,000 each to invest in a basket of companies.  In doing so, their money can be spread out into several different investments instead of being limited to one or two investments.  The money is invested by a manager who makes the decisions on where and how to invest within the confines of the guidelines for the mutual fund.  In exchange, the manager takes a small fee based on the dollar value of the assets in the mutual fund.  Owners of the mutual fund (those who invested) own a fraction of each investment in proportion to the amount that they invested.  In the example above, since each person put in $5000 and there were 10,000 investors, each person would own 1/10,000th of each of the investments.  Normally everyone puts in different amounts and therefore owns different percentages of the mutual funds assets.

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Why should I own mutual funds?

If you save up money regularly, rather than spend money as you go, you provide security for yourself and your family when things happen like car repairs and medical events.  In addition, you’ll have the money needed for expenses such as putting a new roof on your house, college tuition for your children, and retirement that are predictable, but require a great deal of savings.   If you invest some of the money that is sitting around in your savings, you can use the power of compounding to increase your savings, thereby reducing the amount of money you need to actually work for and put away.  Without compounding, it is practically impossible to put away enough money to pay for things like a long retirement.  In addition, if you have money just in cash (or even in a bank account) for long periods of time, you’ll lose a lot of the value to inflation.  Investing the money in mutual funds instead will protect you from inflation since the value of the assets in the mutual funds will go up as the value of the dollar declines.

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How do I invest in mutual funds?

Several different companies sell mutual funds with each fund investing in different things.  This is called a “family of funds.”  Investing is as simple as setting up an account online (or with a phone call) and sending in a check or using an electronic transfer.  There is normally a minimum amount that can be invested in each fund, ranging from $3,000 to $5,000 or more.  Other than saving up the minimum, there is really no trick to it.

Once you’ve made the initial investment, you can normally add to it in small amounts.  There is often no minimum for future investments in the same fund, or maybe there will be a small $25 to $50 minimum.  Once you have enough invested, you can also sell some of your first fund and then invest in a different fund, or just save up the minimum again and invest in a second fund.  Some fund companies also allow you to start with less if you agree to use automatic deposit to buy additional shares on a regular basis.  This is generally a good idea since it will mean you’ll be making regular investments, which is one secret to doing well and building up your portfolio.

You can also buy mutual funds through a brokerage account or even a bank or credit union.  In general I would not recommend this path since you’ll probably have a limited selection of funds and you’ll probably pay a big fee to the broker or bank.  A better option if you’re using a broker is to buy shares of an Exchange Traded Fund, or ETF, which is basically the same thing as a mutual fund.  There are some differences, but that is for a more advanced discussion.  If you buy an ETF you will pay the broker a commission, so you’ll need to buy in big enough increments to keep costs down, but the ETFs themselves tend to be very low-cost, so you’ll make back the money in savings if you hold the ETF for a long period of time even if you only buy in $1,000 or $2,000 increments.  Some brokers may even offer free ETFs.

How do I select mutual funds to buy?

There are many different funds to select from and it can become difficult to choose.  In general you’ll want to try to 1) minimize your fees and costs, 2) spread your investments out into different parts of the market and 3) choose funds based on the amount of time you’ll stay invested.  Assuming you’re investing for something like five, ten, or more years into the future, your first fund will probably be a large-cap fund like an S&P500 fund, large-cap growth fund, or similar.  For really long investments, like a retirement fund when you’re in your 20’s, a small cap fund like a Russell 2000 fund or small-cap growth fund might be a better pick since small stocks will beat larger ones over really long periods of time.  Really you could start with one of these funds and then add the second once you’ve saved up enough.  

If you’re only investing for about five years, you might want to buy into a short-term bond fund or just leave the money in bank assets like CDs since the fluctuation in stock prices over short periods of time is unpredictable.  You might also want to add a bond fund to a stock portfolio when you start to approach the time when you’ll need the money for things like college, a home purchase, or retirement.  In general a combination of bonds and stocks will fluctuate less in value than stocks or bonds alone, although you’ll reduce your total return over long periods of time by adding bonds.  If you just don’t like market fluctuations, however, add 30-40% bonds (for example, $4,000 in a bond fund and $6,000 split between a small cap and a large cap stock fund) and it will make it easier to sleep at night.  Even during the 2008 crash, bonds were unaffected.  In fact, they actually gained a bit for the year!  An REIT fund, which invests in real estate, is also a consideration as a counterbalance to stock mutual funds.  

You’ll want to find a fund with fees of 0.30% of assets per year or less.  (This means that they’ll charge you $3 per year for every $1,000 you have invested.)   This is easiest to achieve using index funds, which just choose stocks in order to follow a specific part of the stock market rather than having a manager who tries to outperform the market.  Because few fund managers are able to actually beat market returns, you’ll generally be best off just buying index funds and index ETFs.

Where can I learn more about mutual fund investing?

There are many books on investing that include mutual funds.  Below are a sample of books that you could read. I’ve included the SmallIvy Book of Investing because the last couple of chapters are devoted to mutual fund investing, including how to use mutual funds to gather money for your retirement.


Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why You Really Need to Invest

You’ll find a lot of blogs on people getting out of debt.  Perhaps they start out with a student loan balance of $150,000 and pay it off over a period of three years.  If they are persistent, and particularly if they see their income rise, perhaps because they get a lot of revenue from their blog and affiliate advertising, they will make their way out of debt.  But what then?

What happens after you pay off that last student loan?  After you close that last credit card account?  You make your last car payment?  You make your last mortgage payment?  And what if you never got into debt in the first place?  Often that’s where the blog stops.

If you want to move from just being debt-free to being financially independent – being able to pay for things without needing to depend on a paycheck – you need a way to make money efficiently.  There is only so much time in the day.  Even if you get a second job, unless you have a phenomenal salary, it is really difficult to simply work and save enough money to reach financial independence.  Plus, your income level is usually limited and it will top out at some point in your career.  If you make an average of $60,000 during your working career and save 10% per year, you’ll have $240,000 over your entire career.  If you save 20%, you’ll still only have about half a million dollars at age 60.  To sustain yourself, you’ll probably need something north of $2 M unless you live a very meager existence.

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One way to attain financial independence is to start a business.  If you start a business and run it well, your potential income is theoretically limitless.  If you open a store and do well, you can open a whole chain.  The same thing goes for a lawn care business, or a manufacturing business, or a restaurant.  Because you can hire people to work for you, and take a small percentage of the amount of money they generate, you can expand your income.  But many businesses fail, and you often need to take a big risk to start a business, possibly borrowing a lot of money.  Starting a business when you already have a family that depends on your income is also risky.  Is there another way?

The answer is investing.

When you invest, it is like you are buying an ownership stake in a business, which means that, just like starting a business, your theoretical income is limitless.  There are people who bought a $5,000 stake in Home Depot or Wal-Mart who are now millionaires.  The beauty of investing is that you get to enjoy the possibility of growth that you get from starting a business, but don’t have all of the headaches that come from actually running a business. You don’t need to check inventory, order supplies, or manage employees.

Not only that, but you get to benefit from other people’s good ideas.  You probably didn’t get the idea to build a search engine that everyone would use, let alone go through the hassle of coding it, getting servers set up, and getting the word out.  But you can buy shares of Alphabet and benefit from the efforts of people who did.  You can buy shares of Walgreen’s and have drug stores on all of the best corners in every city in America.  You can buy into a successful restaurant, a successful credit card issuer, or a successful tobacco company.  If it trades publicly, you can get a stake in the company and take advantage of other people’s good ideas, execution, and hard work.


Want all the details?  Try The SmallIvy Book of Investing.

There are some people who will become rich by working really hard and saving  every dime.  There are others who will become doctors or lawyers, get hired by the right firm or practice or start their own practice, and live on little enough to build up their savings and become wealthy.  There are still others who will start a business and work hard to grow it into a huge company and become wealthy.  For the rest of us, investing is the way to wealth.  If you’re interested in learning how, pick up a copy of The SmallIvy Book of Investing and keep reading The Small Investor Blog.

Have a burning investing question you’d like answered?  Please send to or leave in a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Never Need to Keep Tax Records Again

So today is tax day in America yet again.  Sometime in the last few months you probably had to gather your receipts, W-2 forms, and 1099’s.  You had to buy some tax software or set up a meeting with an accountant.  Either way, you were out at least $100 because the forms are too complicated to someone to just fill out.  You then spent several hours away from your family filling in information.  You probably also had to call various places for receipts, send money or letters of authorization to transfer money into IRAs and HSAs before the deadline.  You then needed to go to the post office and stand in line to send in your forms, or sent them in electronically despite warnings from the IRS that many tax returns are being stolen each year when filed electronically and the information used for identity theft.  You do all this because the law says you need to in order to pay your taxes.

If you’re like most people, you probably also got a big refund check back.  You may look forward to receiving that check, and maybe you use it to pay down a credit card bill or just blow it on something, but realize that is your money that the government had all year-long without paying you a dime of interest.  Maybe you paid credit card interest all year because Uncle Sam was holding onto that money.  At 15% per year, that’s $600 per year you are losing if your refund is $4,000.  Even at $2000 per year, that’s $300 you are losing.

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There is a better way and it’s called the Fair Tax.    With the Fair Tax you would receive your entire paycheck each month with no deductions taken out so your paycheck would be at least 20% bigger.  You wouldn’t pay a dime in taxes until you bought a new item, at which point you would pay a sales tax.  That would be the end of your obligation as far as taxes went.  You wouldn’t need to save any receipts.  You wouldn’t need to file anything.  You would pay at the cash register and then go on with your life.

One argument against a sales tax is that it is regressive since people who make less spend a higher percentage of their income.  This is also addressed in the Fair Tax with a prefund.  Each year (or each month) everyone who works would get a deposit in their accounts from the government to cover a portion of the sales tax they pay.  For example, if the Fair Tax is 20% and you wanted to make sure no one who made less that $30,000 paid anything in taxes, you would issue a prefund of $600 per year to everyone.  Then the prefund would cover the taxes on the first $30,000 you spent.  Only those spending more than $30,000 per year would then be paying taxes.  You could set the prefund as high or as low as you wished depending on how much you needed to collect in taxes and at what income threshold you wished people to start paying taxes.

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Another argument is that people don’t want to be paying a 20% sales tax (an estimate for the sales tax that would be needed to raise the same amount of money as is currently raised through the payroll taxes and income tax).  Realize first of all that you are already paying 12% or more of your income out before you get your check.  Including the employer match for Social Security and Medicare, you are paying around 20%.  This is not just on the money you spend, but also on the money you save.  It is also expected that because retailers will no longer need to spend as much money on tax planning, and because they would no longer pay income tax on their earnings, that prices would fall, perhaps by enough to cover most, if not all, of the sales tax.  It is very likely that the government will be raising the same amount in taxes while you are paying a lower percentage of your (increased) income in taxes.

If this sounds great to you, go to learn more, and learn how you can help get the Fair Tax passed.  Let’s have 2016 be the last year you need to spend time away from your family filling out forms.

What do you think?  Don’t like the Fair Tax?  Why not?  What do you think is the best way to collect taxes? Please leave a comment.

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To ask a question, email or leave the question in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.