How do I invest in mutual funds?

There are a few different ways to invest in mutual funds . If it’s an option for you, the best place to start is the retirement plan offered at your work, like a 401(k). Why? Because it comes with plenty of benefits like: Tax-deferred growth of your investments—or tax-free growth if you have a Roth 401(k) An employer match to your contributions is free money that instantly increases the amount of money put into your 401(k) every paycheck Automatic contributions from your paycheck When you’re looking over the mutual fund options included in your workplace plan, work with your financial advisor to select the best ones. Once you’ve made your selections, invest as much as it takes to receive the full employer match. If you don’t have a workplace retirement plan, or you’ve maxed out your employer’s match, you can open up a Roth IRA and invest in mutual funds there with the help of an experienced investment professional.

How do I choose the right mix of mutual funds?

Like we mentioned earlier, there are thousands of funds out there to choose from—so how do you decide which ones to add to your portfolio? Here are the four main factors to look at when choosing a mutual fund: 1. Look at the fund’s long-term history. When deciding on a mutual fund, it’s important to look at its history and how it’s performed over the last 10–20 years—not just the last year or two. It can be tempting to get tunnel vision and focus only on funds that brought stellar returns in recent years. Instead, take a deep breath, step back, and look at the big picture. You’ll also want to look at the fund’s volatility, which is a measure of how much the fund’s value fluctuates from year to year. Every mutual fund has some level of volatility as values rise and fall with the stock market—funds with high volatility tend to be riskier. But how much is too much? That depends on you and your tolerance for risk. 2. Compare similar mutual funds. You’ll also want to understand how the mutual fund has performed compared to other similar funds in the market over long periods of time. Is it at least keeping up with a good benchmark like the S&P 500, or has it been performing so badly that it’s making even the worst funds look good? All in all, to lower your risk, you want to choose a fund that has a long-running track record of strong returns. 3. Explore the fund’s fees and expenses. To figure out what a fund costs, you’ll want to look at its expense ratio . That’s the percentage of your investment you’ll pay each year to own the fund. You’ll also want to look at sales charges, transaction fees and brokerage charges. Depending on the class of fund you choose these costs will vary. 4. Diversify, diversify, diversify. Whenever you hear the word diversification , that just means you’re spreading your money around. Mutual funds, which are filled with stocks from many different companies, already have a certain level of diversification built into them. And when you add another level of diversification by spreading your investments across those four different mutual fund types we mentioned earlier, you lower your risk even more.

When should I drop a mutual fund from my portfolio?

If a fund doesn’t perform well over the long haul, or if it’s not a good fit for your overall strategy, it may be time to drop that fund from your investing portfolio. Here are some signs to look for when deciding whether to drop a mutual fund. As always, it’s best to talk this decision over with your financial advisor. 1. The expense ratio is too high. Though you should never choose a mutual fund based on its expense ratio alone, understanding a fund’s expenses is important. Every penny you pay toward expenses and fees is money that’s not in your investment—and it’s not moving you closer to your retirement goals. 2. There’s too much turnover. When a fund has a high turnover rate (the percentage of the fund’s holdings that are bought and sold each year) it can lead to big fees and costly taxes for funds outside of a retirement account. It also shows that the management team might be trying to time the market for a bigger return. 3. Your portfolio is out of balance. Over time, as the market fluctuates and shares are bought and sold, your portfolio is bound to change. This may mean you no longer have 25% of your investment in each of the four categories. To get back on track with your strategy, your investment professional can rebalance your funds. This typically happens a minimum of once a year. Remember, balance is the key.

What’s the difference between a mutual fund and an ETF?

Just like their name suggests, exchange-traded funds—or ETFs—are basically funds that are traded on an exchange. They’re similar to mutual funds in lots of ways: They pool money together from many investors to purchase investments for the fund. They’re both managed by a group of financial professionals. They come in a variety of different flavors (there are stock ETFs, bond ETFs and even ETFs that have a mix of both). But there are some important differences between mutual funds and ETFs —the most obvious one being how they are bought and sold. You see, mutual funds can only be bought and sold at the end of the day after the market closes. That’s because the price of a mutual fund is set once a day. You can also set up automatic payments to buy more shares each month, which is a nice feature for long-term investors. That’s not the case with ETFs, which are designed to be traded like stocks. That means the price of an ETF goes up and down throughout the day, and investors can buy or sell them in response to these short-term swings. Because of that, you don’t have the option to set up an automatic payment to buy shares of ETFs like you could with a mutual fund.

Are Christian mutual funds legit?

A Christian mutual fund invests money in companies and causes that line up with Christian values. They usually try to avoid investing in companies that are considered "sin stocks”—things like tobacco, alcohol, gambling and weapons. It’s always a good idea to understand exactly what you’re investing in and noble to want to invest in companies you believe in. But you still need to do your own homework to make sure any Christian mutual fund you’re considering has a long track record of solid returns, just like you would with any other fund. Just because a mutual fund invests in companies that align with your views doesn’t automatically make it a good investment!

What Are Mutual Funds? And How Do They Work?

13 Min Read | Nov 11, 2024

By Ramsey Solutions

Key Takeaways

Mutual funds are professionally managed investments where investors pool their money together to buy investments like stocks and bonds.
The top benefits of investing in mutual funds are instant diversification, lower overall costs, and active professional management.
We recommend spreading your investments evenly between four types of growth stock mutual funds—growth and income, growth, aggressive growth, and international.
You can invest in mutual funds easily through tax-advantaged retirement accounts like your workplace 401(k) plan and a Roth IRA.

If the mere mention of the phrase mutual funds has your eyes glazing over with confusion, trust us—you’re not alone. We’ve all been there. The good news is, they’re not as complicated as you may think.

With the help of an investment professional, mutual funds are a great way to invest for your retirement. But you should never invest in something you don’t understand. So, let’s take a closer look at what mutual funds are, how they work, and why they can become the most valuable tool in your retirement investing strategy.

What Is a Mutual Fund?

Mutual funds are professionally managed investments that allow investors (that’s you) to pool their money together to buy different types of investments—such as stocks, bonds and short-term debt.

Mutual funds usually have a team of professionals working behind the scenes, picking and choosing which stocks, bonds or other investment options to include inside the fund.

Now, how that money is invested will tell you what kind of fund it is. If it’s used to buy stock in international companies, then the fund would be an international stock mutual fund. What if it’s used to buy bonds? Then it would be a bond mutual fund. See? Not that complicated!

How Does a Mutual Fund Work?

Here’s a good way to visualize how mutual funds work: Imagine a group of people standing around an empty bowl. They each take out a $100 bill and place it in the bowl. These people just mutually funded that bowl. It’s a mutual fund. Makes sense, right?

A typical growth stock mutual fund buys stocks in dozens, sometimes hundreds, of different companies—so when you put money in a mutual fund, you’re basically buying bits and pieces of all those companies.

The value of some of those company stocks may go up while others go down, but the overall value of the fund should go up over time. And as the value goes up, so do your returns!

One of the great things about mutual funds is that you don’t need a lot of money to get started, and—thanks to their diversity of investments—you can invest confidently without betting your retirement future on a single stock.

Ramsey’s Complete Guide to Investing

Whether you’re a total beginner or experienced investor, this free guide will teach you what you need to know to invest with confidence.

Get Your Free Guide

What Are the Main Benefits of Mutual Funds?

We’ve covered a lot of ground already, but here are three reasons why mutual funds are the perfect investments to help you save for retirement and build wealth for the long haul:

1. Instant Diversification

You know the old saying, “Don’t put all your eggs in one basket”? That’s diversification in a nutshell—it just means you’re spreading your investments across many different companies, which reduces risk.

Market chaos, inflation, your future—work with a pro to navigate this stuff.

Mutual funds, which can have stocks from hundreds of different companies, make it easy for investors like you to diversify your portfolio because they have built-in diversification.

2. Lower Costs

Trading single stocks can get expensive because you could end up paying transaction fees for every single stock you buy and sell. Those fees add up really fast!

Mutual funds make it affordable to invest in a range of stocks without those pesky transaction fees.

3. Active Management

Index funds and most exchange-traded funds (ETFs) have a “set it and forget it” approach to investing. Like that lazy classmate you had in high school, they’re happy to just copy someone else’s work and call it a day. In this case, they’re copying a stock market index like the S&P 500—they do whatever it’s doing and call it a day.

Mutual funds, on the other hand, are run by a team of investment experts who want to beat the stock market’s returns. They set the fund’s strategy, do their research, stay on top of the fund’s performance, and make adjustments (if needed).

Types of Mutual Funds

Let’s take a closer look at the different types of mutual funds. Today, nearly $25.5 trillion in assets like stocks, bonds, cash and money market accounts are held in more than 8,500 mutual funds—and that’s just in the U.S. alone!¹

Each fund has its own specific investing strategy, and each strategy comes with its own risks and rewards. With so many mutual funds to choose from, trying to pick the right ones might feel overwhelming—kind of like trying to pick a meal from a massive menu.

But don’t worry! We’ll give you a rundown of the main types of mutual funds you should know about:

Stock Mutual Funds

Also known as equity funds, these bad boys are your bread-and-butter mutual funds. Stock mutual funds are invested in stocks from many different companies, but the type of company stocks inside the mutual fund depends on the fund’s overall goals and objectives. Let’s break down the different types of stock mutual funds you can check out.

Growth Funds

These funds invest in companies that have potential for growth in the future. Usually, you won’t get a regular dividend payment from these funds, but you’ll make money when you sell your shares of the fund in the future.

Value Funds

Managers of value funds are the bargain hunters of the investing world. They pack these funds with stocks that seem to be trading for less than they’re actually worth. The idea behind this strategy is that these stocks are “on sale” and will eventually go back up, reflecting their “true value.”

There is a place for value funds in your portfolio (some growth and income funds invest in growth and value stocks). But the problem with value funds is that it’s tough to figure out a company’s true worth or if its stock value will actually grow over time.

Income Funds

Income funds are interested in stocks that pay regular dividends. An investor who wants an income fund probably isn’t worried about how much a stock’s price rises or falls. They’re more concerned with consistently getting a small cut of the earnings from the companies inside that fund throughout the year.

Index Funds

Index funds are designed to mirror the performance of a particular market index by investing in the companies in that index. So, if you look inside the S&P 500 index fund, which is designed to track the progress of the stock market as a whole, you’ll find that the fund only contains stocks from companies that are part of the S&P 500 index.

Specialty Funds

Specialty funds are a type of mutual fund that focuses on specific industries or investment themes. Here are a few common types:

Sector Funds: These funds focus on investing in company stock within a certain industry or sector of the economy. If you’re investing in a technology sector fund, for example, you would look inside that fund’s portfolio and find that the fund is filled with stocks from all kinds of tech companies . . . and only tech companies.

Socially Responsible Funds: Some mutual funds are created to reflect the ethical or moral views of the investor. They might invest in companies dedicated to certain social causes or based on environmental, social and governance (ESG) criteria–such as income equality or carbon emissions. They might also be deemed “ethical” by excluding not-so-awesome products like tobacco. This is also known as impact investing.

Commodity Funds: These funds invest in precious metals (like gold and silver), raw materials and natural resources (like oil and natural gas), and agricultural goods. But there are major problems here—they’re always going up and down, with prices based more on fear and greed than anything else, and they bring in poorer returns over time. Don’t buy into the craze.

Bond Mutual Funds

When you buy a bond, you’re basically lending money to a company or government and, in return, you get a steady stream of income (in the form of dividend and interest payments made to you). So, a bond mutual fund is when a group of investors pools their money together to purchase a bunch of different bonds.

Hybrid Mutual Funds

Hybrid funds invest in a mix of stocks and bonds. This approach tries to balance the potential growth of stocks with the income and stability of bonds over the long haul. There are really two main types of hybrid mutual funds: balanced funds and target-date funds.

Balanced Funds

With balanced funds, the ratio between stocks and bonds is set and doesn’t change. The goal of a balanced fund is to help investors enjoy some of the growth that comes with investing in stocks while creating a steady income stream with bonds.

Unfortunately, balanced funds get weighed down by the lowest performing funds inside the portfolio, robbing you of potential long-term returns on stock mutual funds investing.

Target-Date Funds

Target-date funds shift the balance of your investments from aggressive to more conservative over time based on your desired retirement age. As you get closer to retirement, these funds automatically shift your investments from things like growth stocks to money markets and bonds to decrease volatility and risk. Basically, you’re trying to build a big nest egg first and then protecting it as you get closer to retirement.

The problem with target-date funds is that they might end up so conservative that inflation starts taking a large chuck out of your investment gains. Ouch!

That’s why we recommend keeping growth stock mutual funds in your portfolio (even after you retire) so that your money can still grow and outpace inflation!

Money Market Funds

Money market funds (not to be confused with money market accounts) are mutual funds invested in something called short-term debt securities. What in the world is a short-term debt security? It’s basically money loaned to a government, company or bank for a very short period of time. The money borrowed, plus interest, is usually due back to investors in less than a year.

Like a bond mutual fund, money market funds are supposed to give investors a steady stream of income through regular interest payments . . . but they also won’t make you much money in the long run either.

How Do Mutual Funds Make Money?

If you own a mutual fund, you’re considered a shareholder. You can make a profit from your investments in one of two ways: through dividends or capital gains.

Dividends

Dividends are a reward to shareholders for holding onto certain stocks or mutual funds for the long term. Keep in mind, not all stocks offer dividends, and there are several different types. In most cases, dividends are paid quarterly and in cash. You can either pocket the money or reinvest and buy more shares.

Capital Gains

This money is paid out when your investment is sold for a higher price than what you originally paid for it. (That’s why you hear the phrase, "buy low, sell high.") But you don’t get that money until you sell your shares. Until then, your profits (and losses) are merely on paper—not in your pocket.

Just think of it this way: Dividends are paid at least yearly (but often quarterly), while capital gains are paid out when you sell the investment (if you earned a profit).

What Mutual Funds Should I Invest In?

Now, there are many different types of funds out there, but you should invest evenly across four different types of growth stock mutual funds: growth and income, growth, aggressive growth, and international funds.

See? Told you we’d be back here. Let’s take a closer look at each.

1. Growth and Income (Large-Cap)

Growth and income funds, sometimes called large-cap funds, are mostly made up of stocks from big companies—including some you’ll probably recognize, like Apple or Microsoft—that are valued over $10 billion. They’re more predictable and the calmest type of funds available. Although their returns aren’t always as high as other funds, they’re what many consider to be a low-risk, stable foundation for your portfolio.

2. Growth (Medium-Cap)

Growth funds are just what they sound like: They’re funds invested in medium to large companies that still have room to grow. You’ll sometimes see these funds listed as mid-cap funds. Even though they have a knack for rising and falling with the economy, growth funds are pretty stable overall and usually earn higher returns than growth and income funds.

3. Aggressive Growth (Small-Cap)

Aggressive growth funds—sometimes called small-cap funds—are the “wild child” of mutual funds. When they’re up, they are really up, but when they’re down—watch out! Made up of stocks from companies with a lot of potential for growth (like small tech start-ups or large companies in emerging markets), they’re your chance to take a big risk for a potentially bigger financial reward.

4. International

These mutual funds have stocks from companies outside the U.S.—think BMW, Mercedes and LG—helping investors diversify their portfolios by investing their money in global companies of different sizes beyond American borders. By including international funds in your mutual fund portfolio, you can benefit from the success of well-known companies overseas.

What Fees Come With a Mutual Fund?

You should never decide on a mutual fund based on fees alone, but it’s important to understand the long-term impact of a fund’s fees and expenses. Even a small difference in fees can affect your returns down the road.

There are two types of fees associated with mutual funds: ongoing fees and transaction fees. Under the “shareholder fees” section of the fund’s prospectus, you’ll find both the ongoing fees—which are included in the fund’s expense ratio (cost to operate the fund)—and the transaction fees.

Here’s a breakdown of what’s included in each:

Management Fee: This fee is what you pay to the fund manager or the team of investing professionals who make sure the fund achieves its investing objective and performs well. Typically, this fee falls between 0.5% and 2% of the assets being managed.

12b-1 Fees: These fees pay for the marketing and selling of the fund. They’re capped at 1% of the fund’s assets and are paid directly out of the fund.²

Miscellaneous: These include accounting fees, audit fees, and recordkeeping and legal fees.

Transaction Fees: These include redemption fees, sales charges and trading fees.

We know that’s a lot to remember, and it can get confusing. That’s one of the reasons we recommend you work with an investment professional. These pros can explain the details and your options in easy-to-understand language. That way, you always understand what exactly you’re investing in, including how much you’re paying in fees.

Are Mutual Funds a Good Investment?

The short answer: Yes. Look, there will always be at least some level of risk with investing, but investing with mutual funds is safer than investing in single stocks. Why? Because instead of betting your retirement future on the success or failure of one or two companies, mutual funds help you invest in dozens or hundreds of different stocks all at once.

While bonds (and bond mutual funds) are seen as a “safer” investment with lower risks than stocks, you’ll have to settle for unimpressive returns that barely outpace inflation . . . and why would you want that?

When you spread your investments evenly across the four different types of mutual funds we recommend (growth and income, growth, aggressive growth, and international) you lower your risk while still taking advantage of the growth of the stock market. It’s a win-win!

Next Steps

Use our retirement assessment tool to figure out how much money you might need to retire on your terms and how much you could have to save each month to get there.
Set up a meeting with your HR representative to see if you company offers a tax-advantaged retirement plan along with a company match (that’s code for free money!).
Still have questions about investment options like mutual funds? Our SmartVestor program can connect you with an investing pro who serves your area. They can answer your questions and help you navigate the ups and downs of the stock market.

Find an Investment Pro

Frequently Asked Questions

How do I invest in mutual funds?: There are a few different ways to invest in mutual funds. If it’s an option for you, the best place to start is the retirement plan offered at your work, like a 401(k).

Why? Because it comes with plenty of benefits like:

Tax-deferred growth of your investments—or tax-free growth if you have a Roth 401(k)

An employer match to your contributions is free money that instantly increases the amount of money put into your 401(k) every paycheck

Automatic contributions from your paycheck

When you’re looking over the mutual fund options included in your workplace plan, work with your financial advisor to select the best ones. Once you’ve made your selections, invest as much as it takes to receive the full employer match.

If you don’t have a workplace retirement plan, or you’ve maxed out your

employer’s match, you can open up a Roth IRA and invest in mutual funds there with the help of an experienced investment professional.
How do I choose the right mix of mutual funds?: Like we mentioned earlier, there are thousands of funds out there to choose from—so how do you decide which ones to add to your portfolio? Here are the four main factors to look at when choosing a mutual fund:

1. Look at the fund’s long-term history.

When deciding on a mutual fund, it’s important to look at its history and how it’s performed over the last 10–20 years—not just the last year or two. It can be tempting to get tunnel vision and focus only on funds that brought stellar returns in recent years. Instead, take a deep breath, step back, and look at the big picture.

You’ll also want to look at the fund’s volatility, which is a measure of how much the fund’s value fluctuates from year to year. Every mutual fund has some level of volatility as values rise and fall with the stock market—funds with high volatility tend to be riskier. But how much is too much? That depends on you and your tolerance for risk.

2. Compare similar mutual funds.

You’ll also want to understand how the mutual fund has performed compared to other similar funds in the market over long periods of time. Is it at least keeping up with a good benchmark like the S&P 500, or has it been performing so badly that it’s making even the worst funds look good? All in all, to lower your risk, you want to choose a fund that has a long-running track record of strong returns.

3. Explore the fund’s fees and expenses.

To figure out what a fund costs, you’ll want to look at its expense ratio. That’s the percentage of your investment you’ll pay each year to own the fund. You’ll also want to look at sales charges, transaction fees and brokerage charges. Depending on the class of fund you choose these costs will vary.

4. Diversify, diversify, diversify.

Whenever you hear the word diversification, that just means you’re spreading your money around. Mutual funds, which are filled with stocks from many different companies, already have a certain level of diversification built into them.

And when you add another level of diversification by spreading your investments across those four different mutual fund types we mentioned earlier, you lower your risk even more.
When should I drop a mutual fund from my portfolio?: If a fund doesn’t perform well over the long haul, or if it’s not a good fit for your overall strategy, it may be time to drop that fund from your investing portfolio. Here are some signs to look for when deciding whether to drop a mutual fund. As always, it’s best to talk this decision over with your financial advisor.

1. The expense ratio is too high.

Though you should never choose a mutual fund based on its expense ratio alone, understanding a fund’s expenses is important. Every penny you pay toward expenses and fees is money that’s not in your investment—and it’s not moving you closer to your retirement goals.

2. There’s too much turnover.

When a fund has a high turnover rate (the percentage of the fund’s holdings that are bought and sold each year) it can lead to big fees and costly taxes for funds outside of a retirement account. It also shows that the management team might be trying to time the market for a bigger return.

3. Your portfolio is out of balance.

Over time, as the market fluctuates and shares are bought and sold, your portfolio is bound to change. This may mean you no longer have 25% of your investment in each of the four categories. To get back on track with your strategy, your investment professional can rebalance your funds. This typically happens a minimum of once a year. Remember, balance is the key.
What’s the difference between a mutual fund and an ETF?: Just like their name suggests, exchange-traded funds—or ETFs—are basically funds that are traded on an exchange. They’re similar to mutual funds in lots of ways:

They pool money together from many investors to purchase investments for the fund.

They’re both managed by a group of financial professionals.

They come in a variety of different flavors (there are stock ETFs, bond ETFs and even ETFs that have a mix of both).

But there are some important differences between mutual funds and ETFs—the most obvious one being how they are bought and sold. You see, mutual funds can only be bought and sold at the end of the day after the market closes. That’s because the price of a mutual fund is set once a day. You can also set up automatic payments to buy more shares each month, which is a nice feature for long-term investors.

That’s not the case with ETFs, which are designed to be traded like stocks. That means the price of an ETF goes up and down throughout the day, and investors can buy or sell them in response to these short-term swings. Because of that, you don’t have the option to set up an automatic payment to buy shares of ETFs like you could with a mutual fund.
Are Christian mutual funds legit?: A Christian mutual fund invests money in companies and causes that line up with Christian values. They usually try to avoid investing in companies that are considered "sin stocks”—things like tobacco, alcohol, gambling and weapons.

It’s always a good idea to understand exactly what you’re investing in and noble to want to invest in companies you believe in. But you still need to do your own homework to make sure any Christian mutual fund you’re considering has a long track record of solid returns, just like you would with any other fund.

Just because a mutual fund invests in companies that align with your views doesn’t automatically make it a good investment!

This article provides general guidelines about investing topics. Your situation may be unique. To discuss a plan for your situation, connect with a SmartVestor Pro. Ramsey Solutions is a paid, non-client promoter of participating Pros.

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Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.