But mutual funds also have
features that some investors might view as disadvantages, such as:
Costs Despite Negative
Returns— Investors must pay
sales charges, annual fees, and other expenses (which we'll discuss below) regardless of how the fund performs.
And, depending on the timing of their investment, investors may also have to pay taxes on any capital gains
distribution they receive — even if the fund went on to perform poorly after they bought shares.
typically cannot ascertain the exact make-up of a fund's portfolio at any given time, nor can they
directly influence which securities the fund manager buys and sells or the timing of those trades.
— With an individual stock, you can obtain real-time (or
close to real-time) pricing information with relative ease by checking financial websites or by calling
your broker. You can also monitor how a stock's price changes from hour to hour — or even second to
second. By contrast, with a mutual fund, the price at which you purchase or redeem shares will typically
depend on the fund's NAV, which the fund might not calculate until many hours after you've placed your
order. In general, mutual funds must calculate their NAV at least once every business day, typically
after the major U.S. exchanges close.
When it comes to investing in
mutual funds, investors have literally thousands of choices. Before you invest in any given fund, decide whether
the investment strategy and risks of the fund are a good fit for you. The first step to successful investing is
figuring out your financial goals and risk tolerance — either on your own or with the help of a financial
professional. Once you know what you're saving for, when you'll need the money, and how much risk you can tolerate,
you can more easily narrow your choices.
Most mutual funds fall into one
of three main categories — money market funds, bond funds (also called "fixed income" funds), and stock funds (also
called "equity" funds). Each type has different features and different risks and rewards. Generally, the higher the
potential return, the higher the risk of loss.
Money market funds have relatively low
risks, compared to other mutual funds (and most other investments). By law, they can invest in only certain
high-quality, short-term investments issued by the U.S. government, U.S. corporations, and state and local
governments. Money market funds try to keep their net asset value (NAV) — which represents the value of one
share in a fund — at a stable $1.00 per share. But the NAV may fall below $1.00 if the fund's investments
perform poorly. Investor losses have been rare, but they are possible.
Money market funds pay dividends that
generally reflect short-term interest rates, and historically the returns for money market funds have been
lower than for either bond or stock funds. That's why "inflation risk" — the risk that inflation will outpace
and erode investment returns over time — can be a potential concern for investors in money market
Bond funds generally have higher risks
than money market funds, largely because they typically pursue strategies aimed at producing higher yields.
Unlike money market funds, the SEC's rules do not restrict bond funds to high-quality or short-term
investments. Because there are many different types of bonds, bond funds can vary dramatically in their risks
and rewards. Some of the risks associated with bond funds include:
Credit Risk — the possibility that companies or other issuers whose
bonds are owned by the fund may fail to pay their debts (including the debt owed to holders of their bonds).
Credit risk is less of a factor for bond funds that invest in insured bonds or U.S. Treasury bonds. By contrast,
those that invest in the bonds of companies with poor credit ratings generally will be subject to higher
Interest Rate Risk — the risk that the market value of the bonds will go down
when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest
only in insured bonds or Treasury bonds. Funds that invest in longer-term bonds tend to have higher interest
Prepayment Risk — the chance that a bond will be paid off early. For
example, if interest rates fall, a bond issuer may decide to pay off (or "retire") its debt and issue new bonds
that pay a lower rate. When this happens, the fund may not be able to reinvest the proceeds in an investment
with as high a return or yield.
Although a stock fund's value can rise and
fall quickly (and dramatically) over the short term, historically stocks have performed better over the long
term than other types of investments — including corporate bonds, government bonds, and treasury