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Whether you are a new investor or an experienced one, investing in mutual funds may be an easy way to diversify your holdings. A growing segment of the investment market, mutual funds are professionally managed portfolios whose shares are sold to the public in much the same way that stocks are.

Think of a mutual fund as a way for a giant group of people to pool their money together to have more purchasing power. If you were to invest $100 a month into the stock market, you wouldn’t be able to buy many shares. But if thousands of people invest $100 each month, as a group they can buy substantial shares.

Because fund managers can afford to purchase more shares, they are able to better diversify fund holdings. This, in turn, generally provides you with an instantly diversified portfolio.

Types of Mutual Funds

Thousands of funds are available to investors today, each with its own characteristics. In order to find one that’s right for you, you’ll need to understand the following terms:

Open-end funds – Unlimited shares are sold to investors. These are bought and sold directly through the fund, not in the market.

Closed-end funds – A limited number of shares is available to the public. Once these share are sold, the fund is listed on an exchange and new investors must purchase them in the market.

ETF Funds – An exchange-traded fund, or ETF, is a type of investment company whose investment objective is to achieve returns similar to that of a particular market index. An ETF is similar to an index mutual fund in that it will primarily invest in the securities that are included in the selected market index. An ETF will invest in either all of the securities or a representative sample of the securities included in the index. ETFs may be bought or sold throughout the day in the secondary market, but are generally not redeemable by retail investors for the underlying basket of securities they track.

ETF Risks and other considerations – ETF shareholders are subject to risks similar to those of holders of other diversified portfolios. Although exchange-traded funds are designed to provide investment results that generally correspond to the price and yield performance of their respective underlying indexes, the trusts may not be able to exactly replicate the performance of the indexes because of trust expenses and other factors. An exchange-traded sector fund may also be adversely affected by the performance of that specific sector or group of industries on which it is based.

Load funds – Sales fees and commissions are generally charged.

No-load funds – Sales fees and commissions are not charged, but management fees typically apply.

Fund Categories

Funds are grouped together based on factors such as risk tolerance and strategies. After reviewing your personal circumstances, choose a fund with an objective that adheres to your risk tolerance, timeframe and goals.

Types of Funds

The following list includes some of the more popular groups:

Growth – Designed to produce the highest long-term results, these funds usually maximize capital appreciation with little to no income for the investor. Considered to be a riskier fund group, they primarily invest in companies that have potential for above-average price appreciation.

Growth and income – Much like growth funds, these are designed to produce long-term results. However, these funds also provide income to the investor. Generally, investments are divided among larger, well-seasoned companies and bonds.

Income – Most appropriate for investors seeking higher levels of income, these funds generally invest in common stocks, as well as government and corporate bonds. Normally less volatile than the stock market, they are sensitive to interest rate changes.

There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise.

Capital preservation – Typically offering stability and more safety than other types of funds, these strive to provide a small amount of income to investors. Most invest in short-term, fixed-income investments.

The Prospectus: What Is It?

For more complete information about mutual funds – including charges and expenses – please ask for a prospectus. Read your prospectus carefully before you invest or send money. The mutual fund is required to provide this to you free of charge when requested. Some items to look for in the prospectus include:

Objective – A prospectus tells you what goals the fund seeks to achieve. Make sure these objectives are in line with your pre-determined objectives.

Risks – risk factors should be considered and reviewed before purchasing a mutual fund. There is no assurance the Fund will achieve its investment objective. Shares of mutual funds are subject to investment risk, including possible loss of the principal amount invested, and will fluctuate in value. You may receive more or less than you paid when you redeem your shares. Examples of other risks include but are not limited to; stock market risk, interest rate risk and currency risk.

Track record – Funds are required to disclose results from previous years. Review the fund’s one-year, five-year and 10-year track record for a more accurate view of past performance. But remember, past performance does not guarantee future results.

Fund management – An important aspect of the fund, the money manager’s experience and tenure may affect performance. Also, if the current money manager has not been around long, the previous track record may be irrelevant.

Costs – While returns aren’t predictable, costs certainly are. The prospectus discloses any expenses related to the fund and how they are passed along to the investor. Review this section carefully for a complete understanding of any expenses related to the fund.

Statement of Additional Information (SAI) – In addition to the prospectus, funds publish an SAI, which covers other items not mentioned in the prospectus. If you are still unsure about investing in a particular fund, request an SAI. One should be provided to you free of charge.

Why invest in mutual funds?

There are three main reasons to invest in mutual funds:

Diversification – In today’s volatile economy, spreading assets among different investments may help reduce the risks associated with investing. Mutual funds can offer instant diversification to investors who otherwise may not have the purchasing power to do so. However, diversification does not ensure a profit or protect against a loss.

Convenience – Mutual funds are easy to purchase. Investors can simply match their risk tolerance, objectives and time line to an appropriate mutual fund. Professional managers do all the work.

Professional management – Funds are handled by professionals who have both experience and knowledge of the industry. These managers conduct all the necessary research, and manage all transactions in the account.