When you’re new to investing, it can be hard to figure out where to start. That’s where mutual funds come into play: They offer access to hundreds – even thousands – of stocks or bonds with a single share, making diversification affordable for anyone.
Most of us can’t afford to buy enough individual stocks and bonds to balance out risk – that kind of portfolio calls for at least $100,000 of investing money. So mutual funds even the odds by creating those big portfolios and letting us buy shares of them.
As useful as they are, mutual funds do come with some drawbacks.
- They trade only once at the end of the day for a set price (called the NAV, or net asset value), unlike stocks or ETFs (exchange-traded funds) that you can buy or sell at any time for the current market price. You have to buy (or redeem) mutual funds directly from (to) the fund company.
- Most mutual funds require minimum investments ranging from $1,000 to $5,000, which makes it a little harder for some people to get started investing.
- Funds charge fees – some upfront and obvious, some hidden from plain sight – that can eat into your earnings. The main fees are referred to as expense ratios, and they can range from a tiny 0.05% to a hundred times more at 5%.
- Many funds charge “loads,” which means sales fees or commissions when you buy or redeem shares. Look for no-load funds to avoid these extra costs.
Professionally managed mutual funds (where a fund manager chooses everything stock or bond in the fund) have higher fees than index mutual funds, which simply mirror the holdings of a market index.
Because of the lower fees, index mutual funds work best for beginner portfolios. Generally speaking, you want to look for funds following broad indexes (like total stock or bond market or the S&P 500, for example) with fees under 1%.
There are a lot of mutual fund families to choose from. I tend to go for fund families with no-load index funds and low fees. My favorite mutual fund families include Vanguard (great reputation) and Charles Schwab (super low fees).
If you can only afford one mutual fund at the beginning, go with a total stock market index fund. If you can afford two, add a total bond market fund. Then, as you build your portfolio, you can start to add some twists.
Here are some good choices to look at to get you started:
- Vanguard Total Stock Market Index Fund (VTSMX)
Minimum investment = $3,000
Expense ratio = 0.15% - Vanguard Total Bond Market Index Fund (VBMFX)
Minimum investment = $3,000
Expense ratio = 0.15% - Schwab S&P 500 Index Fund (SWPPX)
Minimum investment = $100 (with automatic monthly $100 deposits, otherwise minimum = $1,000)
Expense ratio = 0.03% - Schwab International Index Fund (SWISX)
Minimum investment = $100 (with automatic monthly $100 deposits, otherwise minimum = $1,000)
Expense ratio = 0.06% - Vanguard FTSE Social Index Fund (VFTSX)
Minimum investment = $3,000
Expense ratio = 0.22%
Funds like these can set a solid foundation for your personal portfolio, and put you on the path toward building real wealth. The most important step to take is the first one, because the sooner you start investing, the more time your money has to grow.