Do You Know How Do Mutual Funds Work?

By Janet Calhoun

Today mutual funds are still very popular as investments, so can you be sure you know how do mutual funds work? In bad economic times like these, mutual funds may still be good investments, but only if you understand the ins and outs of investing in them.

Mutual funds are one of the reasons the stock market has been growing - as billions of dollars are invested through retirement funds and individual investment accounts. They have historically offered a good way to diversify one's investment portfolio, and reduce risk.

Mutual Funds have a special structural status since they are owned by all of the investors together. Each investor owns a proportional share of the underlying investments. When investors buy shares, their money is used by the fund managers to purchase shares in investment vehicles, like stocks and bonds, that meet the objectives of the funds.

In the past, many investors invested their money with the belief that the funds they purchased were managed by financial professionals, and that stocks in the market have historically gone higher, and so investing in mutual funds would be fairly safe and secure investments for the long run. Yet it's clear given the recent economic downturn that was not the case. It's important to recognize that it's nearly impossible to profit by just buying and sitting on investments without having to reallocate at all over a period of time.

With investors feeling like they didn't have to watch what was going on with their funds, many people have lost more than they expected based on what they were told about the risks. This is why it's so important to understand how do mutual funds work, as well as learning to invest money on your own, and choose stocks. Investors need to get away from the idea that buying a few mutual funds is all they need to do.

When you are about to choose a mutual fund to invest in, start with reviewing your personal financial plan and decide which funds fit in with your overall wealth plan. Review for each fund the investments within the fund, and look beyond the fund's returns. Even with returns down for most funds right now, there are some, like bond or balanced funds, that can offer decent returns. You need to know more than ever what you are investing in, and learn to invest with an eye toward market volatility.

Spend some time comparing the fund's investments to those within other, similar funds. Understand exactly what all of the underlying stocks and bonds are that the fund is buying. don't just blindly send money to the "growth" fund or the "balanced" fund without knowing what companies you are buying - and consider where these companies might be in the next three, five or ten years if there is a long term sluggish economy. By learning more about how do mutual funds work, you are more likely to profit from your investments.

Learn more about how do mutual funds work? Janet Calhoun writes on how to learn to invest for online and offline publications.

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