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Why invest in mutual funds? Mutual fund basics for beginners

If you're new to investing, mutual funds are a great place to start learning the basics.

Updated

4 min. read

Investing can be a great way to build your wealth but the question is, where should you put your money?

If you're a first-time investor, you may want to consider the merits of mutual funds as you lay the foundations of your portfolio. Not sure where to begin? Read on to learn more about mutual funds.

Mutual fund basics: What are mutual funds?

Before you learn how to invest in a mutual fund, you first need to understand what they are. A mutual fund pools money from different investors to purchase a portfolio of investments, such as stocks, bonds, cash and other mutual funds or exchange-traded funds (ETFs). Individual investors own shares in the mutual fund and the value of those shares can increase or decrease, based on the value of the underlying investments.

Mutual funds are overseen by a professional portfolio manager, who manages the fund according to its overall investment goals. They can offer you several benefits, including:

Professional Management – Be at ease knowing your investments are in the hands of investment professionals
Diversified Portfolio – Reduce your risk by spreading investments across more securities
Broad range of investments – Invest throughout the world across sectors and asset classes
Ability to buy and sell daily – Conveniently access your money when you need it

Another benefit to mutual funds is that you can invest with a relatively low entry point. It's possible to begin building a mutual fund portfolio with as little as $500.

“For those just starting their investment journey, mutual funds can prove the more agreeable choice. More advanced investors who prefer to customize how, and when, they invest their money, may find that stocks call to them more profoundly.”

How to invest in a mutual fund

1. Understand your investment goals: Investing in mutual funds begins with thinking about what you're trying to get from your investments. For instance, you might be ready to invest for retirement. Or, you may be saving for your first home. Understanding your objective can help you figure out which funds can get you to your destination.

Next, think about your timeline for reaching those goals and how much risk you're comfortable taking on. Remember that there's a trade-off between risk and rewards. The higher the risk, the more rewarding a mutual fund may be, and vice versa.

2. Do your research: Once you've gotten those steps out of the way, you can move on to comparing different funds. There are several things to consider, starting with the investments the fund holds. Some funds, for example, include companies in specific sectors, like technology or energy. Some may be exclusive to larger U.S. companies while others focus on international companies or bonds.

For example, BMO's SelectTrust® Portfolios include a fixed income option that primarily invests in bonds, an equity growth option that includes both U.S. and foreign stocks, and a balanced option that holds a mix of bonds and stocks.

Also, think about how important it is for a mutual fund to generate cash flow. Some funds pay a regular dividend to their investors monthly, quarterly or annually. If a fund pays dividends, you may be able to reinvest it in additional shares or receive a cash payout.

Tip: If you want to defer taxes on growth, consider keeping your funds inside a tax-advantaged retirement account like an RRSP.

Finally, consider the cost. A common way to measure a mutual fund's cost is the expense ratio. The expense ratio is an annual fee the fund charges to its shareholders. It represents the percentage of assets deducted for fund expenses each year, which includes 12b-1 fees, management fees, administrative fees and operating costs. This does not include transaction fees or brokerage costs, which are other fees you may have to account for.