How to Invest in Mutual Funds

To start investing in mutual funds, you can buy shares:

• Directly, usually online, from the investment firm that operates the mutual fund. Some of these firms also operate as fund “supermarkets,” that let you buy funds from other companies.
• From intermediaries, such as financial planners or brokers.
• Through retirement plans such as your employer’s 401(k) plan. Many people do this to save for retirement.⁵

The price of a share in the mutual fund is based on the fund’s “net asset value” (NAV), which is the total value of the securities in the portfolio divided by the number of the fund's shares.⁶ This price can go up or down, based on the value of the securities in the fund at the end of each business day. If the price goes up, the value of your investment increases. If the price falls, your investment shrinks. 

One convenient aspect of mutual funds is that you can invest in dollar amounts that work for you, rather than having to buy a specific number of shares. Many funds require a small initial investment, but after that you may be able to add smaller amounts. You may also be able to set up automatic regular payments – say, monthly – that can be even smaller.

All mutual funds charge fees. There are two main types:

• Loads. Some funds charge sales fees or commissions, called loads, when you buy or sell shares in the fund. Funds that don’t charge these fees are called “no-load” funds.^7,8
• Expense ratios. These represent the cost of managing the fund during the year. All funds charge these fees, generally as a percentage of the amount invested.^9,10

A fund with high fees must perform better than a low-cost fund to generate the same return on your investment. Even small differences in fees can mean a big difference to how much your investments grow over time, according to the SEC. For example, a $10,000 mutual fund investment with a 10% annual return and an expense ratio of 1.5% would grow to nearly $50,000 after 20 years. A similar investment and performance with an expense ratio of 0.5% would end up over $60,000 – earning more than $11,000 extra.³

The good news is that fees have fallen over time. The average expense ratio for mutual funds that invest in stocks dropped from 0.99% in 2000 to 0.44% in 2022, according to an investment industry association.¹¹

There’s an extraordinary variety of mutual funds to choose from – almost 7,400 in the United States in 2022, according to Statista.¹² They vary widely in their performance, investment approach, and level of risk, so research carefully before you invest. The SEC recommends reading the “prospectus” that each fund is legally required to produce, which describes the fund’s investment objectives, risks, performance, and expenses.³

Common types of funds include:

• Stock or equity funds. This is the biggest category of mutual funds. Equity funds buy stocks of publicly traded companies. Some funds aim for very high financial returns with more risk, while others are more conservative. Funds may buy a broad spread of different stocks, or they may focus on specific industry sectors.^3,13
• Bond funds. Instead of buying stocks, these funds invest in bonds, which are essentially loans to corporations or governments who pay you back at a fixed rate of return.¹⁴
• Index funds. Increasingly popular in recent years, these “passively managed” funds simply track the performance of a specific stock or bond index, such as the S&P 500 index of the 500 largest U.S. publicly traded companies.¹⁵
• Balanced funds. Invest in a mixture of stocks, bonds, and other assets.^16,17
• Money market funds. Invest in specific low-risk, short-term assets.³
  

Some funds take an active money management approach: They aim to beat the stock market by picking winners and/or frequently buying and selling stocks to take advantage of short-term price fluctuations. These funds generally have higher fees. In contrast, index funds use a passive money management approach, which generally results in much lower fees. Instead of putting effort into picking winners, they simply adjust their stock holdings automatically when companies enter or leave the index they track.¹⁵

Passively managed funds such as index funds have become increasingly popular.¹⁸

You can earn money from a mutual fund in several ways, depending on the fund:

• Dividend or interest payments. Funds may earn money from dividends paid on their stock holdings, or interest on bonds. Depending on the fund and your preference, the fund’s provider may either reinvest that money in the fund or send it to you.
• Capital gains. If a fund sells stocks at a higher price than when it bought them, it makes money termed capital gains, and reinvests or distributes it to shareholders.
• Increased fund share price. If the fund’s share price increases – for example, if the stocks held by the fund rise in value – the value of your investment will increase.³