Mutual Fund Investing for Beginners

Updated on May 20, 2020
Earl Noah Bernsby profile image

I have a BA in Natural Sciences and Mathematics and am currently working towards a Certificate of Finance from TESU. (Only 3 credits to go!)

Finally — an easy mutual fund tutorial for the busy working Joe/Jane! (Photo credits are located at the end of this article.)
Finally — an easy mutual fund tutorial for the busy working Joe/Jane! (Photo credits are located at the end of this article.)

Does This Sound Like You?

You work hard for your money! At least eight hours a day (five days a week) you’re out there paying your dues and making a contribution to society — just trying to carve out that well-deserved slice. Even more than that: you’re responsible. You aren’t drowning in debt, and every payday you squirrel away a percentage of your earnings. As a result, you have a tidy sum lying around collecting dust — maybe in a separate savings account at the bank (earning abysmal returns), or maybe even stuffed inside your mattress (earning zero returns).

Moreover, you have heard good things about mutual fund investing, but the learning curve for breaking into this sweet racket seems pretty steep. And who can afford to spend the requisite time searching through an endless stream of websites, books and videos just to learn the bare essentials, in order to get up and running with mutual funds quickly — that is, without having to inadvertently acquire CFA (Certifed Financial Analyst) credentials along the way?

But have no fear, good sir/madame, because that’s where I come in:

Allow myself to introduce...uhh... myself. The name’s Earl (nice to meet you), and I’m a working stiff just like you. Only, I’ve taken the liberty of doing the legwork involved with researching mutual funds for you. I’ve scoured every inch of the globe (Re: internet, public library, local bookstores) in search of information on the topics you will learn about in this article, and I’ll gladly share my knowledge with you for free.

Don’t be intimidated by mutual funds — they’re easy!
Don’t be intimidated by mutual funds — they’re easy!

In this tutorial, Mutual Fund Investing for Beginners, everything that you need to know about investing in mutual funds will be covered. Consider it your one-stop-shop for becoming (quickly) acclimatized to the wonderful world of these sublime securities, and for getting started making all of your hard-earned money work hard for you!

What Are Mutual Funds (and Why Should I Care)?

In this article, I’ll explain mutual funds in plain English — what they are, exactly, and why they are such a great investment for busy people with limited time (and limited tolerance) for all of that Wall Street mumbo-jumbo that you’ve heard on the financial channel.

I've also written other helpful pieces on mutual funds. These are best read in the following order:

Different Varieties of Mutual Funds: In this article, we’ll explore the different categories of mutual funds, as well as the benefits of investing in particular sorts of funds within those categories, rather than other (more expensive) alternatives.

Selecting the Best Mutual Funds: Here I show you how to get down to the nitty-gritty, and I’ll show you how to determine the good funds from the bad (and ugly); the bargains from the rip-offs; the best from the rest!

I also cover the following in Mutual Funds: Asset Allocation, Retirement Planning, Choosing a Broker & Further Reading.

  • Mutual Fund Asset Allocation Formula (by Age and Risk Tolerance): At this point, you’ll learn a simple method for calculating your personal investing strategy for mutual funds, based on your age and risk tolerance.
  • Investing for Retirement: Retirement might be right around the corner for you, or it may be years off. But whatever your situation, the sooner you start planning for your golden years the better! In this article, I get into the benefits of investing in mutual funds through a tax-sheltered retirement account — like an IRA or a 401(k) — so that you can decide whether or not pursuing such a course of action would be a good choice for you. (Spoiler Alert: It probably is!)
  • Choosing a Mutual Fund Company and/or Brokerage Firm: Time to let the rubber hit the road! Here, we’ll discuss whether or not it would be a better option for you to purchase mutual funds directly from their parent companies or through an online brokerage firm, and then I’ll point you in the right direction to start investing right away!
  • List of Some of the Top Mutual Funds in the Country (by Category), and Investor Education Resources: What mutual fund how-to-guide worth it’s salt wouldn’t list some stellar funds for you to check out? In this article, I’ll give you a list of some of the most well-respected funds around, separated by category. Additionally, I'll list reputable investment education websites and financial newsletters for you to get familiar with. The resources listed in this section will give you plenty of extra content to pour over and learn from, should you decide to take your investment game to the next level. (However, if you would rather not dive into the torrent of market minutiae that has consumed both mighty and meek alike, rest assured that this piece is strictly optional!)

Curb market at Broad Street, in New York City. It later became the American Stock Exchange. In the background, the New York Stock Exchange building can be seen under construction.
Curb market at Broad Street, in New York City. It later became the American Stock Exchange. In the background, the New York Stock Exchange building can be seen under construction.

What Are Mutual Funds (and Why Should I Care)?

So, what are mutual funds anyway? How do they work? For that matter — why should you care? Let me explain it like this:


Say that your family runs a small pizzeria. Everyone in the family has a job to do to ensure the smooth operation of the restaurant. You are responsible for picking up all of the necessary ingredients used in pizza making, and for making sure that the restaurant is always well-stocked. Nana keeps the place spic-n-span, and she also answers the phone. Pappy makes the pies, Junior makes the deliveries, and so on
and so forth.

Then, there's Poindexter...

What Poindexter lacks in social graces, he makes up for in financial acumen. He has a shrewd business sense, is an absolute whiz at marketing, and has keen managerial instincts. Poindexter handles the finances. All of the
money that comes into and goes out of the pizzeria passes through him. His job is to make sure that the business makes sound financial decisions — in order to
make a profit, of course! This arrangement works well for him and for the rest of the family, because everyone gets to focus on doing what they are good at without
being forced to handle affairs that fall outside of their respective wheelhouses.

Re: “Poindexter”
Re: “Poindexter”

Now imagine that instead of your (hypothetical) pizzeria-owning family in the example above, a group of complete strangers decide to team up. Also, instead of working together in a restaurant, they choose to pool their money together into one big pot. Finally, picture the role of “Poindexter” as being played by an expert who specializes in taking big pots of money, for the purposes of investing them into a myriad of financial securities, in order to return — well — an even bigger pot of money (to be shared by everyone who contributed in the first place)!

A mutual fund is simply a group of people who have decided to combine their money in such a way, who then turn over all of the decisions for investing that money to experts (called fund managers). In this way, people with absolutely no interest in following the stock market are able to reap the substantial rewards gained through investing (i.e., by leveraging the knowledge and experience of professional investors). Such people are then free to go on with their lives while all of the hard work involved with making their money grow is handled by other, more interested parties.

What is a mutual fund?

A mutual fund is a pool of money created by many contributing individuals (personal investors), who then turn over the responsibility for investing that money to professional managers. Any returns that are realized by the investments are shared among the fund’s contributors.

Now, you may be thinking: That’s all fine and good Earl, but — why should I care?

It’s a reasonable question. After all, is it really worthwhile to fork over your hard-earned money to a complete stranger to invest, when you could just tuck a portion away in a savings account like many people do? Would that not be a safer choice, in light of the known volatility of the stock market?

While it is true that there is risk associated with investing in stocks, bonds, and other financial securities, the fact of the matter is that when you average the market’s performance over time, you will see that investors have earned an average annual return of about 10%.1 This is an average return that persists in
spite of the occasional market catastrophe that has been known to shake up our economy (such as the famous stock market crash of 1929).

That’s a pretty impressive track record! On the other hand, even the highest-yield savings accounts can’t touch average market returns, as demonstrated below in Table 1. As you can see, it would take ten years for a principal invested in a savings account — offering a paltry .87% return on your money — to approach comparable returns as the same amount of money invested in a mutual fund (earning the historic market average of 10%) for one year.

TABLE 1: Comparison of a $10,000 Principal Employed in Three Different Ways Over a Period of Ten Years

 
 
 
 
Time
UNDER THE MATRESS
HIGH-YIELD SAVINGS ACCOUNT (.87% ANNUAL INTEREST)
MUTUAL FUND (10% ANNUAL INTEREST)
1 yr.
$10,000
$10,087
$11,000
5 yrs.
$10,000
$10,442.64
$16,105.10
10 yrs.
$10,000
$10,904.86
$25,937.42
*For simplicity, this chart disregards fees, sales commissions, and other advanced topics, which will be covered in more detail in the following sections. **The formula used for compounded interest calculations will be discussed in Section IV.

So, to answer the question of whether or not investing in mutual funds is worth it:

Yes, yes, and yes again!

However, before you can decide which mutual fund(s) to purchase, you’ve got to learn how to distinguish between all of the different types of funds that are available. You also need to know how to tell a good fund from a bad one. In the following sections, we will cover these — and many more — topics in detail.

Click here to read an article of mine about Different Varieties of Mutual Funds.

Resources

1. Wikipedia contributors. Stock market [Internet]. Wikipedia, The Free Encyclopedia; 2013 Sep 18, 13:23 UTC [cited 2013 Sep 23]. Available from: http://en.wikipedia.org/wiki/Stock_market#United_States_S.26P_stock_market_returns

Photo Credits

1. ‘A welder for Combustion Engineering Co. makes boilers for a ship in Chattanooga, TN.’ (Finally — an easy mutual fund tutorial for the busy working joe/jane!). Source: Original photo by Alfred T. Palmer, Public Domain (i.e., This is a U.S. Government work and is not subject to copyright under U.S.
law: learn more), via Wikimedia Commons. Circa 1942 (cited 2013 Sep 20). Derivative photo by E.N.B.

Original photo available from: http://commons.wikimedia.org/wiki/File:Boilermaker_-
_Alfred_T_Palmer.jpg

2. ‘L’Utilisateur: Nicolas_Perrault_III apparemment confus.’ Source: Olivier Perrault, CC0 1.0, via Wikimedia Commons. 23 Nov 2012 (cited 2013 Sep 20). Available from: http://commons.wikimedia.org/wiki/File:User_Nicolas_Perrault_III_23_November_2012.JPG

3. ‘Curb market at Broad Street, in New York City.’ Source: Falk, Public Domain (i.e., This photo was taken before 1923: learn more.), via Wikimedia Commons. 15 Jul 1902 (cited 2013 Sep 20). Available from: http://commons.wikimedia.org/wiki/File:Curb_market_at_Broad_Street_1902.jpg

4. ‘Sedentary Lifestyle: Obesity and Computers.’ Source: FBellon, CC-BY 2.0, via Flickr. 2011 Nov 6 [cited 2014 Feb 28]. Originally taken from: http://www.flickr.com/photos/55158656@N06/

5. ‘A sign on Wall Street, as captured during the venting of an adjacent steam stack.’ Source: Paul Sparkes, Public Domain (i.e., Released by author), via Wikimedia Commons. 2007 Mar 04 (cited 2013 Sep 20). Available from: http://commons.wikimedia.org/wiki/File:Wall-Street.jpg

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

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