How to invest in Mutual fund

If you were studying for a test on mutual funds or if you were handed the task of giving a presentation on the basics of investing mutual funds, here are key 10 definitions that you need to know:

Mutual Fund Definition: A mutual fund is an investment security type that enables investors to pool their money together into one professionally managed investment. Mutual funds can invest in stocks, bonds, cash and/or other assets. These underlying security types, called holdings combine to form one mutual fund, also called a portfolio.Now for the simple explanation: Mutual funds can be considered baskets of investments. Each basket holds dozens or hundreds of security types, such as stocks or bonds. Therefore, when an investor buys a mutual fund, they are buying a basket of investment securities. However, it is also important to understand that the investor does not actually own the underlying securities--the holdings--but rather a representation of those securities; investors own shares of the mutual fund, not shares of the holdings.

1. Mutual Fund Loads: Loads are fees charged to the investor when buying or selling certain types of mutual funds.There are four types of loads: Front-end loads are charged up front (at the time of purchase) and average around 5% but can be as high as 8.5%. For example, if you invest $1,000 with a 5% front load, the load amount will be $50.00 and therefore your initial investment will actually be $950. Back-end loads, also called contingent deferred sales charges, are charged only when you sell a back-loaded fund. These charges can also be 5% or more, but the load amount typically declines over time and can be reduced to zero after a certain number years. Load-waived funds are funds that normally charge a load but waive it if there is some qualifying circumstance, such as purchases made within a 401(k) plan. No-load funds do not charge any loads. This is the best type of fund to use because minimizing fees helps maximize returns.When researching mutual funds, you can identify the load types by the letter 'A' or 'B' at the end of the fund name. Share class A funds are front-loaded funds and share class B are back-loaded funds. Sometimes the load-waived funds have the letters 'LW' at the end of the fund name. Once again, be sure to look for no-load funds. A few good no-load mutual fund companies include Vanguard, Fidelity, and T. Rowe Price.

1. Mutual Fund Share Class: Each mutual fund has a share class, which is basically a classification of how the fund charges fees. There are several different types of mutual fund share classes, each with its own advantages and disadvantages, most of which center upon expenses. Class A shares are also called "front load" funds because their fees are charged on "the front" when the investor first buys shares of the fund. The loads typically range from 3.00% to 5.00%. A shares are best for investors who are using a broker and who plan to invest larger dollar amounts and will buy shares infrequently. If the purchase amount is high enough, investors may qualify for "breakpoint discounts." Class B Share Funds are a share class of mutual funds that do not carry front-end sales charges, but instead charge a contingent deferred sales charge (CDSC) or "back-end load." Class B shares also tend to have higher 12b-1 fees than other mutual fund share classes.For example, if an investor purchases mutual fund Class B shares, they will not be charged a front-end load but will instead pay a back-end load if the investor sells shares prior to a stated period, such as 7 years, and they may be charged up to 6% to redeem their shares. Class B shares can eventually exchange into Class A shares after seven or eight years.

Therefore they may be best for investors who do not have enough to invest to qualify for a break level on the A share, but intend to hold the B shares for several years or more. Class C Share Funds charge a "level load" annually, which is usually 1.00%, and this expense never goes away, making C share mutual funds the most expensive for investors who are investing for long periods of time.The load is usually 1.00%. In general, investors should use C shares for short-term (less than 3 years). Class D Share Funds are often similar to no-load funds in that they are a mutual fund share class that was created as an alternative to the traditional and more common A share, B share and C share funds that are either front-load, back-load or level-load, respectively. Class Adv Share Funds are only available through an investment advisor, hence the abbreviation "Adv."

These funds are typically no-load (or what is called "load waived") but can have 12b-1 fees up to 0.50%. If you are working with an investment advisor or other financial professional, the Adv shares can be your best option because the expenses are often lower. Class Inst Share Funds (aka Class I, Class X, or Class Y) are generally only available to institutional investors with minimum investment amounts of $25,000 or more. Load-Waived Funds are mutual fund share class alternatives to loaded funds, such as A share class funds. As the name suggests, the mutual fund load is waived (not charged). Typically these funds are offered in 401(k) plans where loaded funds are not an option. Load-waived mutual funds are identified by an "LW" at the end of the fund name and at the end of the ticker symbol. For example, American Funds Growth Fund of America A (AGTHX), which is an A share fund, has a load-waived option, American Funds Growth Fund of America A LW (AGTHX.LW). Class R Share Funds do not have a load (i.e. front-end load, back-end load or level load) but they do have 12b-1 fees that typically range from 0.25% to 0.50%. If your 401(k) only provides R share class funds, your expenses may be higher than if the investment choices included the no-load (or load-waived) version of the same fund.

1. Expense Ratio: Even if the investor uses a no-load fund, there are underlying expenses that are indirect charges for use in the fund's operation. The expense ratio is the percentage of fees paid to the mutual fund company to manage and operate the fund, including all administrative expenses and 12b-1 fees. The mutual fund company would take those expenses out of the fund prior to the investor seeing the return. For example, if the expense ratio of a mutual fund was 1.00%, and you invested $10,000, the expense for a given year would be $100. However, the expense is not taken directly out of your pocket. The expense effectively reduces the gross return of the fund. Put differently, if the fund earns 10%, before expenses, in a given year, the investor would see a net return of 9.00% (10.00% - 1.00%).

2. Index Funds: An index, with regard to investing, is a statistical sampling of securities that represent a defined segment of the market. For example, the S&P 500 Index, is a sampling of approximately 500 large capitalization stocks. Index funds are simply mutual funds that invest in the same securities as its benchmark index. The logic in using index funds is that, over time, the majority of active fund managers are not able to outperform the broad market indexes. Therefore, rather than trying to "beat the market," it is wise to simply invest in it. This reasoning is a kind of "if you can't beat 'em, join 'em" strategy. The best index funds have a few primary things in common. They keep costs low, they do a good job of matching the index securities (called tracking error), and they use proper weighting methods. For example, one reason Vanguard has some of the lowest expense ratios for their index funds is because they do very little advertising and they are owned by their shareholders. If an index fund has an expense ratio of 0.12 but a comparable fund has an expense ratio of 0.22, the lower cost index fund has an immediate advantage of 0.10. This only amounts to only 10 cents savings for every $100 invested but every penny counts, especially in the long run, for indexing.

1. Market Capitalization: With investment securities market capitalization (or market cap), refers to the price of a share of stock multiplied by the number of shares outstanding. Many equity mutual funds are categorized based on the average market capitalization of the stocks that the mutual funds own. This is important because investors need to be sure of what they are buying. Large-cap Stock Funds invest in stocks of corporations with large market capitalization, typically higher than $10 billion. These companies are so large that you have probably heard of them or you may even purchase goods or services from them on a regular basis. Some large-cap stock names include Wal-Mart, Exxon, GE, Pfizer, Bank of America, Apple and Microsoft. Mid-cap Stock Funds invest in stocks of corporations of mid-size capitalization, typically between $2 billion and $10 billion. Many of the names of the corporations you may recognize, such as Harley Davidson and Netflix, but others you may not know, such as SanDisk Corporation or Life Technologies Corp. Small-cap Stock Funds invest in stocks of corporations of small-size capitalization, typically between $500 million and $2 billion. While a billion-dollar corporation may seem large to you, it's relatively small compared to the Wal-Marts and Exxons of the world. A subset of small-cap stocks is "Micro-cap," which represents mutual funds investing in corporations with average market capitalization usually less than $750 million.

1. Mutual Fund Style: In addition to capitalization, stocks, and stock funds are categorized by style which is divided into Growth, Value or Blend objectives. Growth Stock Funds invest in growth stocks, which are stocks of companies that are expected to grow at a rate faster than the market average. Value Stock Funds invest in value stocks, which are stocks of companies that an investor or mutual fund manager believe to be selling at a price lower than the market value. Value Stock Funds are often called Dividend Mutual Funds because value stocks commonly pay dividends to investors, whereas the typical growth stock does not pay dividends to the investor because the corporation reinvests dividends to further grow the corporation. Blend Stock Funds invest in a blend of growth and value stocks. Bond funds also have style classifications, which have 2 primary divisions: 1) Maturity/Duration, which is expressed as long-term, intermediate-term, and short-term, 2) Credit quality, which is divided into high, investment grade, and low (or junk).

2. Balanced Funds: Balanced Funds are mutual funds that provide a combination (or balance) of underlying investment assets, such as stocks, bonds, and cash. Also called hybrid funds or asset allocation funds, the asset allocation remains relatively fixed and serves a stated purpose or investment style. For example, a conservative balanced fund might invest in a conservative mix of underlying investment assets, such as 40% stocks, 50% bonds, and 10% money market.
3. Target Date Retirement Funds:This fund type works like its name suggests. Each fund has a year in the name of the fund, such as Vanguard Target Retirement 2055 (VFFVX), which would be a fund best suited for someone expecting to retire in or around the year 2055. Several other fund families, such as Fidelity and T. Rowe Price, offer target date retirement funds. Here's basically how they work, other than just providing a target date: The fund manager assigns a suitable asset allocation (mix of stocks, bonds, and cash) and then slowly shifts the holdings to a more conservative allocation (less stocks, more bonds and cash) as the target date draws closer.

4. Sector Funds: These funds focus on a specific industry, social objective or sector such as health care, real estate or technology. Their investment objective is to provide concentrated exposure to specific industry groups, called sectors. Mutual fund investors use sector funds to increase exposure to certain industry sectors they believe will perform better than other sectors. By comparison, diversified mutual funds--those that do not focus on one sector--will already have exposure to most industry sectors. For example, an S&P 500 Index Fund provides exposure to sectors, such as healthcare, energy, technology, utilities, and financial companies. Investors should be careful with sector funds because there is increased market risk due to volatility if the sector suffers a downturn. Over-exposure to one sector, for example, is a form of market timing that can prove harmful to an investor's portfolio if the sector performs poorly.