What are some of the benefits and risks of mutual funds?

The purpose of this post is to provide the reader with a general description of certain risks and rewards associated with investing in mutual funds.  Please keep in mind that this information is being provided for educational purposes only and is not designed to be complete in all material respects.  Thus, it should not be relied upon as legal or investment advice.  If you have any questions concerning this post, you should seek qualified professional assistance.

Mutual funds offer professional investment management and potential diversification. They also offer three ways to earn money:

  • Dividend Payments. A fund may earn income from dividends on stock or interest on bonds. The fund then pays the shareholders nearly all the income, less expenses.
  • Capital Gains Distributions. The price of the securities in a fund may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, the fund distributes these capital gains, minus any capital losses, to investors.
  • Increased NAV. If the market value of a fund’s portfolio increases, after deducting expenses, then the value of the fund and its shares increases. The higher NAV reflects the higher value of your investment.

All funds carry some level of risk. With mutual funds, you may lose some or all of the money you invest because the securities held by a fund can go down in value. Dividends or interest payments may also change as market conditions change.

A fund’s past performance is not as important as you might think because past performance does not predict future returns. But past performance can tell you how volatile or stable a fund has been over a period of time. The more volatile the fund, the higher the investment risk.

When considering an investment in a mutual fund, it is imperative that you obtain and read the prospectus for the fund.  The prospectus will provide you with details concerning the specific investment objectives of the fund, how the fund will attempt to go about meeting those objectives and the risks to which your investment will be exposed.  If the risks contained in the prospectus don’t fit your investment profile, do not take the risk.