If you’re preparing to invest your money, you’ve probably heard of the different types of funds. But what exactly are funds, and what are the differences in different types of funds?
A fund is a grouping of investments bundled into one single investment, so you can purchase into the one large group that spreads your money into multiple areas. The three main types of funds are mutual funds, index funds, and hedge funds, and they all have aspects that should be considered before you decide where to put your money.
A mutual fund is an investment portfolio created by a single person or small group. They decide what stocks they believe will perform better than the others and purchase them, selling ones they decide they don’t want.
It is a passive investment where other people do all the work and make the choices for you, but it comes with higher fees because you have to pay the people in charge of the mutual fund.
If the fund selector makes a poor choice, you could lose your investment. Still, these people are paid to be good at watching the market and making choices that will give you a high return.
The Motley Fool, a popular financial blogger, says, “There are some funds — or, more precisely, some fund managers — whose services are worth paying for because they are superior investors who are simultaneously fee-conscious.” You just need to look carefully and try to find the right one if you want to invest in mutual funds.
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When you invest in an index fund, you essentially invest in a large number of places all at once. For example, an investment into an S&P 500 index fund means you are purchasing a portion of every single one of the 500 companies that make up that large-cap equity. This minimizes risk because of the diversification and gets you returns that are similar to the market average returns.
Index funds are popular because of their simplicity and the low number of fees. Since nobody is actively buying or selling stocks, you put the money in, allocate your portfolio to whichever indexes you want, and let it sit and earn you money.
A hedge fund is an investment portfolio set up by a money manager, somewhat similar to a mutual fund, except the portfolio is designed specifically to minimize risk by “hedging bets.” Essentially, they try to choose investments that are inversely correlated (when one goes up, the other goes down), so that no matter what happens, the investments overall make money.
In theory, this sounds like a more secure choice, since the concept has you making money no matter what. In practice, though, it tends to be riskier since there aren’t really inversely correlated investments out there. They can still make a lot of money, depending on the money manager in charge of the fund.
The key to choosing the best fund to invest in is to evaluate your risk levels as well as your faith in the stock market versus a selector or money manager. If you want something that’s not very risky and expects the stock market to continue its historically steady climb (when looked at over long periods of time), index funds are an easy way to invest with very little paid out in fees.
If you believe in a specific mutual fund selector to outperform the stock market, the additional fees may be worth it, or if a hedge fund manager appeals to you and you’re willing to take on more risk, you may want to allocate money into a hedge fund.
Whatever you decide to do, research the specific fund you’re planning on investing with to ensure you’re making a good decision. If you choose wisely, you could find your money working hard for you, snowballing into a large chunk of cash that will help you reach your long-term goals.
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