The best practice to follow when thinking about investing in mutual funds is to begin before you invest any funds. Mutual fund investing is a goal-oriented planning process.
Determining Your Mutual Fund Investing Goals
Do you have specific goals, such as saving for retirement, or do you have some broadly defined goals, such as the accumulation of wealth for the general purpose of strengthening your financial security? What is your time horizon? One year? Five years? Ten years?
Having a goal in mind for your investments will aid in making related investment decisions, such as the mutual fund types to choose, tax considerations, and how much money it will take to get started.
Find the Right Type of Mutual Fund for You
There are many different types of mutual funds, but all you need to know to begin is the three basic types: stock funds, bond funds, and money market funds. There are also hybrids, usually called balanced funds, which invest in some combination of the three basic types.
Generally, stock mutual funds are appropriate for long-term periods (more than 10 years); bond funds are appropriate for intermediate-term periods (five to 10 years), and money market funds are appropriate for short-term periods (less than three years). Other than time horizon, you will want to know and understand your risk tolerance.
Mutual Fund Taxation
The taxation of mutual funds depends upon which type of investment account you use. Some accounts such as IRAs give the investor tax advantages over standard brokerage accounts.
These are also called regular brokerage accounts or individual brokerage accounts. You will pay capital gains tax on the gains and ordinary income tax on dividends, if applicable.
Now you are ready to buy shares of a mutual fund with an initial investment at a mutual fund company or discount brokerage firm. Many mutual funds require a minimum initial investment amount, which can often be $3,000 or more. However, there are a few good alternatives, such as T. Rowe Price, TIAA, and Vanguard that have funds with low minimums of $100, $500, and $1,000, respectively. You may also consider Fidelity Investments and Charles Schwab.
If you commit to an automatic investment plan, where you invest at least $100 per month, you may get started investing at a lower initial investment amount. Also, when investing with mutual funds in a 401(k), there isn’t a minimum investment amount. All that is required to get started is to complete the employer’s paperwork.