Mutual Fund FAQ
Q: What are mutual funds, and how do I invest in them?
A: A mutual fund is a collection of several individual equities or bonds that trade as one unit. You can invest in a mutual fund by purchasing shares directly from the mutual fund company or a brokerage house.
Q: Are there any good books on mutual fund investing?
A: "Mutual Funds for Dummies" provides the basics of mutual fund investing. For more advanced investors, books by John Bogle, founder of the Vanguard Group, and Peter Lynch, former manager of the Fidelity Magellan Fund, detail specific insights and strategies.
Q: How do I read a mutual fund's historical performance?
A: The prospectus will likely list the fund's performance over the past one, three, five, and 10-year periods. The increase or decrease in the net asset value (NAV) will be compared to other funds in the category and to a broader market benchmark like the S&P 500. However, investors should also look at the fund's total annual return for these periods, too, as this includes earnings from dividends and capital gains.
Q: How are mutual fund beneficiaries taxed?
A: A mutual fund held in a non-qualified account qualifies for a stepped-up cost basis. That means the fund is inherited at its fair market value on the day the owner died, not the day the owner purchased it. In other words, if the owner purchased the fund at $5 per share and it is worth $10 per share on the day he or she dies, the beneficiary is able to claim a cost basis of $10, not $5, which means that capital gains taxes will not be as great when the fund is sold.
A: A spouse who inherits a mutual fund held in a qualified account and chooses to roll the entire value of the account into his or her own IRA will not pay tax on the distribution. If he or she is over age 70 ½ and must take mandatory distributions, they will be taxed as ordinary income. A non-spouse beneficiary can take a lump sum distribution, which will be taxed at ordinary income rates. He or she also has the option of rolling the account over into a beneficiary IRA and taking yearly distributions. These are also taxed at ordinary income rates.
Q: How do I select one particular mutual fund for investment?
A: It depends on your investment goals, your investing time horizon, and what, if any, other mutual funds and investments you own. For many investors, a no-load, low-cost index fund is a good choice if there's only one fund in the portfolio.
Q: Is it wise to invest with different mutual fund companies?
A: If one mutual fund company does not offer a range of funds to invest in, it might be wise to invest with different companies. For example, a company that offers a large-capitalization value fund may not offer an emerging markets fund.
Q: Why is it bad for a mutual fund to have too many assets?
A: The larger a mutual fund becomes, the harder it is for the fund manager to manage it effectively and earn a decent return.
Q: What is the difference between a blend, value, and growth mutual fund?
A: A blend fund holds a combination of value and growth stocks. Value funds specialize in companies that are perceived to be trading lower than their true market value. Growth funds consist of companies that are expected to appreciate over time.
Q: How can I invest in a mutual fund and have my funds held in a foreign currency?
A: There are a number of mutual funds and ETFs that specialize in foreign currency. These funds attempt to increase share value by taking advantage of daily fluctuations in currency exchange rates.
Q: What happens to my money if my mutual fund company goes bankrupt?
A: Even if the company that manages your mutual fund goes bankrupt, it does not mean that the fund itself is bankrupt. A mutual fund is not owned by a company, but by the shareholders. It also has a board of directors that could elect a new management company if the original company were to declare bankruptcy.
Q: How much can an average positive mutual fund profit over 3 to 5 years?
A: Because there is no limit to the amount of profit that can be earned on individual stocks, there really is no limit to the amount of profit in a mutual fund. Practically speaking, however, a fund manager would want to at least make the same profit as the benchmark he or she compares the fund to.
Q: How are mutual funds inherited?
A: Mutual funds, both those held in qualified and non-qualified accounts, are inherited the same way stocks are.
Q: Why are mutual fund companies with high expenses still around?
A: Many investors prefer a mutual fund manager who actively manages the fund. For example, emerging market funds will have higher expenses than index funds because the manager must make almost daily decisions as to whether the assets in fund should be sold or new ones should be added.
Q: How are mutual fund earnings taxed?
A: If the mutual fund is within a tax-qualified account, earnings are not taxed. If the fund is in a brokerage account, the earnings are distributed to all shareholders, who are required to pay taxes at their regular rate if the gains are short term or at the capital gains rate if the earnings are long term.
Q: Can I write off mutual fund losses from one year to offset gains in the next?
A: Yes. The amount of the loss that you can deduct may be different from one year to the next depending on current tax law, but you can usually deduct losses in the year that they occur. If the amount of the loss exceeds the amount that can be written off, the additional amount can be carried into the next year (or years).
Q: Are mutual funds taxed as short or long -term capital gains?
A: Shares that are sold within one year of purchase are subject to short-term capital gains. Shares that are sold after one year of purchase are subject to long-term capital gains.
Q: What is a no-load mutual fund?
A: A no-load mutual fund is one that does not charge a fee on the purchase of shares, which is known as a front loaded fund, or upon the sale of shares, which is known as a back loaded fund.
Q: Do mutual funds pay dividends?
A: Mutual funds do not pay dividends. But they do distribute dividends that are paid by the companies whose stocks are in the fund.
Q: How do I get the cost basis of a mutual fund sale?
A: One method of calculating the cost basis of mutual fund shares is "first in first out". This method assumes that the first shares purchased are the first shares sold. The "average cost" method averages the cost of all purchases, including reinvested capital gains and dividends. This method also requires investors to determine whether the sale is subject to long- or short-term capital gains.
Q: How can I find out what stocks are in a mutual fund?
A: With index funds such as those that track the S&P 500, the Dow 30, and the Russell 2000, the stocks can be found with any online search using the index as the keyword. For other funds, you can visit the website of the fund family and look up the fund in question. Bear in mind, however, that fund management is a proprietary business. Most funds will only list the top holdings, or will not list the amount of each stock held.
Q: Is it risky to have all my assets in one mutual fund family?
A: Not necessarily. Even if the fund company goes bankrupt, the funds themselves will not. If, however, one fund family does not offer enough funds for you to be fully diversified, you'll need to buy funds from more than one company.
Q: What is the difference between a mutual fund and an ETF?
A: Mutual funds and ETFs both hold numerous assets and trade them as one. Mutual funds are professionally managed, have a net-asset value that is determined at the end of the trading day, and charge expenses above and beyond the broker's fee. Further, because the fund manager decides when and how many shares of each stock to buy and sell, an investor has no control over the resulting tax consequences. ETFs trade like stocks, have a share value that fluctuates throughout the day, and have no additional fees other than those charged by the broker upon the purchase and sale of shares. The owner of ETF shares chooses when to sell shares, thereby controlling the time at which taxable events are triggered.
Q: What are reasonable expense fees for a mutual fund?
A: When it comes to index funds, never pay a sales charge, otherwise known as a "load". Annual fees should not exceed 2% and 12b-1 fees (the fees a fund company charges investors for marketing costs) should not exceed .25%. For specialty funds, it also makes sense to purchase a no-load fund rather than a load fund. Expenses will vary dramatically based on the type of the fund and the fund manager. A good way to judge the amount of the expenses is to compare them to other funds in the same sector.
Q: What's the difference between owning company stock versus a mutual fund?
A: Owning the stock of a company means you participate in the profits and losses of that stock only. Mutual funds own shares of several, sometimes hundreds of stocks. The goal is to diversify the stocks so that losses will be offset by gains.
Q: When is interest on a mutual fund paid out?
A: Most funds will distribute earnings quarterly or annually.
Q: What are the pros and cons of buying annuities vs investing in a no-load mutual fund?
A: Annuities are contracts that cannot be cancelled without penalty. The advantage of a fixed annuity is that it will pay a guaranteed amount regardless of market conditions. No-load mutual funds do not charge a sales fee when purchased or sold. Their value, however, rises and falls with the value of the securities contained within it.
Q: Should I make a lump-sum contribution to my mutual fund or take advantage of dollar-cost averaging?
A: If you intend to contribute to a mutual fund like a savings account, in other words you plan on making a $500 deposit each month, then it's best to do that in order to take advantage of dollar-cost averaging. If, however, you've inherited a large amount of money or have cash from the sale of property or another asset, you'll want to weigh the pros and cons. The pros of investing it all at once include an increase in the value of the account if the net-asset value increases. The cons of not investing it all at once include a loss of earnings if money is kept in a savings or money market account that does not earn as much as the mutual fund.
Q: Is there any benefit to buying mutual funds inside a retirement account?
A: Yes, there are many benefits to buying mutual funds inside a retirement account. First, mutual funds offer instant diversification. Second, they offer professional money management. Third, all earnings are tax-deferred.
Q: What is the benefit of putting your money into an overseas mutual fund?
A: For American investors, the primary benefits are reduced expenses and tax liability. Buyer beware, however, when it comes to purchasing overseas mutual funds. Expenses are less because there are fewer regulatory requirements and taxes may not always be less once the money is repatriated.
Q: How important is the fund manager to a mutual fund's success?
A: For index funds, the role of the fund manager is limited. For specialty funds, the fund manager is critical to the success of the fund. He or she will usually have vast experience and insight into the both the market and the types of companies that are within the fund.
While we've covered the basics of mutual fund investing here, there is much more to maximizing the success of your fund investment strategy. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.
More Mutual Fund Guidance
- Mutual Funds Investment Guide — The complete guide to mutual fund investing.
- Equity and Bond Funds — Understanding how equity and bond funds work.
- Balanced, Index, and Specialty Funds — Comparing balanced, index, and specialy funds.
- Exchange Traded Funds — Explore how EFTs compare to traditional funds.
- Money Market Funds — Explore how money market funds work.
- Best Mutual Funds — Factors affecting mutual fund rates, and how to find the best ones.