Interested in investing in some mutual funds? Don’t know where to start or what all the different terms mean? Here’s a quick guide to the different kinds of mutual funds, what, if any, fees are associated with them and of what kinds to steer clear.

Here’s the general idea with mutual funds.

A mutual fund is a collection of individual stocks. This gives you ownership of a small fraction of each of the stocks in the fund. You get instant diversification even if you only buy one fund.

There are 3 broad styles of mutual funds:

Growth stocks are shares of companies whose profits and revenues are growing fast.

Value stocks have their share price lower than the true value of the company, an “undervalued” stock. Here you would buy a value stock at a cheap price and hope its value increases to a ‘good’ price. Key here is patience.

Blend funds contain both growth and value characteristics.

There are also 3 size categories:

Small-cap funds owns shares of smaller companies. Typically newer, fast-growing companies.

Mid-caps are stocks of fast-growers but have more stability than small-caps.

Large-caps are the least risky in that the companies in this type of fund are large, established mature companies.

Management style of the fund:

Actively managed funds have a professional money manager whose full-time job is to select the best stocks (companies) to put in a particular fund. The portfolio manager decides what to buy and what to sell. So if you have a lousy manager, the fund will also have a less than stellar performance.

Unmanaged funds have, quite plainly, no manager. These are also called index funds. An index fund tracks an existing market index, which represents a portion of the market. A popular index is Dow Jones Industrial Average which is made up of 30 stocks. If the stocks in this index perform well, the Dow Jones average goes up. So instead of checking all 30 companies, you can look at one number and get the average performance for the overall market. Also, the Standard & Poor’s 500 Stock Index tracks, well, 500 large established companies. The NASDAQ Composite tracks all the stocks traded on the NASDAQ exchange which are the smaller, newer, fast-growing companies.

Typically, in the long run, index funds outperform most actively managed mutual funds because the returns are higher since there aren’t as many associated fees.

Speaking of fees, let’s cover those now.

Expense Ratios and Loads:

The Expense Ratio represents the annual fees charged to cover the operating costs for the fund.

Actively managed funds carry an expense ratio of 1.5%. Translation: You deduct 1.5% off the performance of the fund each year to pay the manager.

An index fund, say Vanguard 500 Index, charges .18% a year.

Here’s an example of what the different percentage fees really equate to:

Say you invest $3,000 a year, for 30 years and earn 8%. After you pay the fund manager his 1.5%, you net $276,000

Same scenario with an expense ratio of .18%. You net $354,000.

That’s a $78,000 difference!

Next type of fee is a load, a sales commission used to pay the financial adviser who sold you the fund.

While all funds have expenses ratios, not all of them have loads.

There are 3 fee structures for mutual funds:

A-share funds charge a sales commission (load) when you invest. Up to 5%.

B-share funds charge the load when you leave the fund if you don’t stay for a prescribed period, typically 5 years. But since you’re not paying the commission upfront to the salesman, I mean, er, financial adviser, the fund company fronts you the money. They recoup their money by sneakily charging you a 12b-1 fee every year. What is more, if you try to leave the fund before the prescribed period you also get hit with the back-end load, a surrender charge. Plus, if you’re buying the fund with your 401k or Roth money, an adviser didn’t help you buy this fund but you are still charged all the same fees as if one did.

No-load funds quite simply don’t charge a load, or a fee to buy or a fee to sell, no matter when you leave the fund.

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