Don’t have huge sums of money to invest? Then consider buying investments that provide automatic diversification — mutual funds. Mutual funds pool money from many investors to buy a portfolio of stocks, bonds, or other securities.
How They Work
Mutual fund shareholders receive a portion of any income — such as dividends or interest — that comes from the fund’s holdings. If the fund sells investments at a profit, the resulting capital gains — minus any capital losses — are distributed to shareholders, typically at year-end. Generally, you can choose between receiving the distributions in cash or reinvesting the income to buy more fund shares. Unless you hold the fund in a tax-favored retirement plan, you’ll generally owe tax on the income even if it’s reinvested. (Distributions of tax-exempt municipal bond interest aren’t subject to federal income taxes.)
Net asset value (NAV) is a mutual fund’s per-share value. NAV increases when the market value of the fund’s portfolio increases and decreases when the market value declines. The fund’s income and expenses also affect its NAV. If you eventually sell your shares for a higher price than you paid for them, you’ll have a taxable capital gain.
Index or Actively Managed?
Index funds track the performance of a particular stock or bond index and hold only securities that mirror the index. Funds generally have low transaction costs and capital gains distributions. But, the manager can’t trade securities in response to market conditions.
With actively managed funds, the manager selects investments and decides when to trade them. The manager can trade securities in an attempt to improve performance, but frequent trading may increase transaction costs and taxable capital gains distributions.
The risks of investing in mutual funds include fluctuating prices and the uncertainty of dividends, rates of return, and yield.
You should consider a fund’s investment objectives, charges, expenses, and risks carefully before you invest. A fund’s prospectus, which can be obtained by calling your financial representative, contains this information and other information about the fund. Read the prospectus carefully before you invest or send money. Shares when redeemed may be worth more or less than their original cost. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio, or that diversification among different asset classes will reduce risk.
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