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A mutual fund is an investment vehicle that pools money from many investors to purchase a collection of securities (stocks, bonds, or other investment vehicles). When you purchase one or multiple “shares” of the fund, they represent part ownership of the fund along with the other investors.
The collection of securities is referred to as the fund’s portfolio, which is operated by one or more portfolio managers. The portfolio manager is responsible for seeking out future investment opportunities that can help the fund outperform the standard, also known as a benchmark. Mutual funds tend to invest in a range of companies and industries to diversify their portfolio.
To purchase a share of a mutual fund, you can buy it straight from the fund itself or through a broker. The share is purchased at the net asset value (NAV), which is determined by dividing the total value of the securities in the portfolio by the total number of shares. This is updated daily.
Shares can be purchased or traded once a day. If purchased before the close of the market at 4 p.m. ET, the purchase price is that day’s closing NAV; if purchased after 4 p.m., they’re purchased at the next day’s closing NAV. Stocks and exchange-traded funds (ETFs) differ in trading styles since those can be traded throughout the course of the day.
Mutual funds tend to have minimum initial investments, typically in the $250 to $3,000 range. However, there are situations when the minimum can be waived or reduced.
So, how do you earn a return on your investment? It’s simple: When the market value of the fund’s portfolio increases, the value of the fund and its shares increases as well. This raises the value of your investment. Then you can sell your shares at the higher NAV and realize your gain. (Note: There are taxes you must pay on gains, which we’ll get to later.)
Mutual funds provide investors the opportunity to purchase professionally-managed, diversified securities that can be sector-specific. They are also easily accessible through brokerage firms or mutual fund companies, and accounts can be opened quickly. Mutual funds also are affordable investment opportunities with relatively low account minimums and management costs.
Investing in a mutual fund is not free. There are costs that shareholders must pay, which are broken into two categories: shareholder fees and annual fund operating expenses.
Let’s start with shareholder fees. There are five to be aware of:
There are also annual fund operating expenses. These charges are recurring payments that count as the operating expenses for the fund. They come directly out of fund assets so you’re paying these expenses indirectly rather than seeing a charge and paying it.
As a shareholder, you are required to report any of the mutual fund’s distributions on your personal tax return, as well as any shares you buy or sell. In addition, since you’re a part owner of the mutual fund, you also pay taxes on any transactions made by the fund itself as part of the management of the portfolio.
Distributions can be taxed in one of two ways: your ordinary income tax rate or the capital gains rate. If the mutual fund has held the security for less than a year, gains are taxed at the ordinary income tax rate; those held for a year or more are taxed at the capital gains rate. This is an important distinction because the capital gains tax rate tends to be lower than your ordinary income tax rate.
Investing can be a helpful method of planning for the future, whether it’s your retirement or any other financial goal. To learn how we can help you invest for the future, visit us online or schedule a Citizens Retirement Checkup® at your nearest Citizens Bank branch.
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