Wall Street sign (Photo by Paul Sparkes)

Mutual Fund Investing for Beginners

Mutual Fund Tutorial for the Working Man (by E.N.B.)
Finally — an easy mutual fund tutorial for the busy working Joe/Jane! (Photo credits are located at the end of this article.)

Mutual Fund Investing for Beginners

Tell me if this sounds familiar —

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 (Certified Financial Analyst) credentials along the way?

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

Allow me to introduce 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.

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!

How This Mutual Fund Tutorial is Organized

For your convenience, I have divided the tutorial up into eight easily navigable sections.  Details about the topics covered in each section are as follows:

Intimidated by Mutual Funds? (Photo by Olivier Perrault)
Don’t be intimidated by mutual funds — they’re easy!

Section I. What Are Mutual Funds (and Why Should I Care)?  Here, 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.

Section II. Different Types of Mutual Funds That Are Available to Investors: In this section, 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.

Section III. Identifying the Best Mutual Funds: In Section III it will be time 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!

Section IV. 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.

Section V. 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 Section V, 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!)

Section VI. 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!

Section VII. List of Some of the Top Mutual Funds in the Country (by Category): What mutual fund how-to-guide worth it’s salt wouldn’t list some stellar funds for you to check out?  In Section VII, I’ll give you a list of some of the most well-respected funds around, separated by category.

Section VIII. Investment Education Websites and Financial Newsletters: Dear friends, at this point we will have come to the end; or perhaps, the end of the beginning?  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 Section VIII is strictly optional!

Curb Market at Broad Street in NYC (circa 1902)
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.

Sedentary Lifestyle (Photo by FBellon)
Re: “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.

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.

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 account in America can’t touch average market returns, as demonstrated below in Table 1.2 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.

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 paragraphs, we will cover these — and many more — topics in detail.

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

Under the Mattress
High-Yield Savings Account (.87% annual interest)
Mutual Fund (10% annual interest)
1 yr.
5 yrs.
10 yrs.

*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.

In a Nutshell: Mutual Funds Definition

Wall Street sign (Photo by Paul Sparkes)
Read on to “demystify” your understanding of mutual funds!

Remember!  Mutual funds are pools 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.

Different Types of Mutual Funds That Are Available to Investors

In the last section, we talked about how mutual funds are (essentially) a big pool of money created by the contributions of many, many investors like you and me.  Decisions about how this money is invested are made by mutual fund manager(s).  In this way, folks who are eager to share in the historic returns enjoyed by the stock market — but have no desire to wade neck-deep into the why and how of Wall Street operations (Technical stock analysis, market trends, interest and inflation rates, oh my!) — can leverage the knowledge of professional financiers whose job it is to make their investors’ money earn money.  Essentially, once a person has invested a principal amount into a mutual fund, all of the hard work involved with earning returns on that capital (through the buying and selling of various financial securities like stocks and bonds) is handled by someone else!
Unlike Henry VIII, mutual fund managers aren’t despots! At the end of the day, managers are accountable to shareholders.

Let me take a moment to clarify, though, lest you begin to form an image in your mind of autocratic fund managers, who wield absolute power over how your hard-earned money is invested:

There are specific guidelines that managers must adhere to when buying and selling securities that largely depend on a fund’s market strategy.  As such, investors are able to maintain a measure of control over how their money is invested, by purchasing shares of mutual funds that are in keeping with their investment style, risk tolerance and financial goals (more on determining an investment plan that is right for you in Section IV).  But, what are the different kinds of funds?

Mutual funds can generally be classified as fitting into one of four categories:

  • Stock Funds
  • Bond Funds
  • Hybrid Funds
  • Money Market Funds

While some funds will mix and match between their primary specializations — according to the overall investment strategy detailed in the fund’s prospectus (an informational package provided by parent companies that describes everything you wanted to know about a specific mutual fund) — these classifications will give you a basic idea of what kinds of funds are available.  Within the parent groupings of stock and bond funds, there also exist sub-categories which I will detail below.  Hybrid funds generally combine the traits of two or more different kinds of funds (usually stock and bond), but if you understand stock and bond funds, then you can easily grasp the concept of hybrids.  Money market funds, discussed last, are the most straightforward.

Stock Funds

Mutual funds that invest capital in the companies that make up the stock market are (conveniently) called stock funds.  What this means is that all of the money that investors have pooled together for a fund of this type will be invested in stocks — from whichever companies the fund manager(s) think will produce the best returns for investors — within the market sectors that the fund specializes in. (I.e., If a fund focuses on large companies located within the U.S., then its manager(s) will seek to acquire stocks from whichever companies meeting that geographic restriction that they think are poised to do well.  Contrarily, if a fund focuses on foreign companies, then most — if not all — of the stock holdings for the fund will be with companies located in countries outside of the U.S.)

Furthermore, stock — sometimes called equity — funds may be divided into the sub-categories of growth or value funds.  Growth funds are comprised of stocks from companies with a high share price in relation to their assets, and are therefore considered to be more volatile.  On the other hand, value funds are made up of stocks that are priced cheaply compared to company assets, and are expected to experience less in the way of volatility.  Essentially, growth funds are riskier but have a higher potential for return, and value funds are more secure but less likely to experience the rapid gains that growth funds are poised to make (under favorable market conditions).

It is usually a good idea to spread your stock mutual fund holdings out over several funds that focus on different market sectors.  For example, if you divide the money that you have earmarked for stock fund investment into fourths, then one fourth of the money could go into a fund that focuses on small U.S. companies.  Another fourth will be used to purchase a fund that specializes in medium-sized U.S. companies.  Yet another fourth gets put into a fund that invests in large U.S. companies, and the last fourth goes into a fund that invests internationally.  In this way, your stock mutual fund portfolio can be reasonably diversified across the market, while simultaneously positioning you to earn the returns that have historically been observed in the overall stock market (about 10% per year, remember?).  You are merely protected if one or more sectors fair badly in a down market.

Alternatively, you could invest seventy-five percent of the capital that you have earmarked for stock securities in a mutual fund that follows the overall U.S. market — such as Vanguard’s Total Stock Market Index (ticker symbol: VTSMX) — and twenty-five percent in an international fund , such as Oakmark’s Oakmark International I (OAKIX), and you will have achieved a comparable level of diversification in your portfolio to the previous example.  Also, there is nothing to stop you from investing three-fourths of your investment capital internationally, and one-fourth domestically! There are no rules set in stone for diversifying your stock mutual fund portfolio, although it is good practice to invest so that the separate slices of your investment pie combine to form a complete picture of the entire market.

(See Section VII for a list of highly respected mutual funds, arranged by family and market categorization.)

In any event, an important consideration when choosing which funds to invest in are the fund’s total operating expenses, which are discussed in detail in Section III.  For now, just know that the variety of stock funds that have the lowest expenses are known as index funds.  Moreover, index funds such as Vanguard’s famous S&P 500 Index Fund (ticker symbol: VFINX) usually outperform around seventy-five percent of their actively traded, “non-index fund” brethren.3 When you are finally ready to begin purchasing mutual funds (hopefully, after reading this tutorial), it is strongly recommended that you purchase funds of the index variety.

Table 2: 60 Years of Growth for the ‘Standard & Poor’s 500’ Stock Market Index

S&P500 (1950-12)
S&P 500 Closing Values (1950-2012) along with 1, 2 and 3 year moving averages.

Fun Facts: Market Cap & Index Funds

Market-capitalization (or “Cap”) refers to the size of a stock issuing company.  It is the price per share multiplied by total shares outstanding.  The most common (arbitrary) designations that you are likely to hear, are:

  • Small-cap: Less than two billion dollars
  • Medium-cap: Greater than two billion but less than ten billion dollars
  • Large-cap: Greater than ten billion dollars

Index Funds like Vanguard’s S&P 500 Index (ticker symbol: VFINX) keep expenses low by buying and holding, minimizing trading, and passively mirroring the benchmark that they follow, rather than by trying to “actively” beat the market. The proof is in the pudding with index funds, as they have historically outperformed about seventy-five percent of actively traded funds!

Bond Funds

For ultra-conservative investors (*yawn*), some bond funds are usually considered to be a safer alternative to stock funds.  The drawback is that the most reliable bond funds don’t earn anywhere near the returns that stock funds do!  However, there is something to be said for piece-of-mind, and if you are willing to sacrifice earning larger returns on your investments in order to avoid the dramatic fluctuations that the stock market has been known to experience, then you may want to place more of your holdings into some solid conservative bond funds (see Section IV to learn an easy formula for calculating your recommended investment allocation, based on age and risk tolerance).

Bond funds can be classified into three general categories: short-term; intermediate-term; long-term.  Short-term bond funds are the least volatile, and are generally considered to be “safest.”  Naturally, these conservative short-term bond funds also earn the smallest returns. Long-term bond funds are at the other end of the spectrum, and are by far the most “risky” members of the bond fund family.  These funds enjoy more in the way of potential returns, due to this added risk.  Intermediate-term bond funds, as you have probably already deduced, fall in between the two extremes.

Investing in bond funds can get complicated in a hurry.  First, you must make the decision to invest in funds that pay higher — but taxable — yields, or tax-free funds that pay lower yields.  Moreover, the sales and marketing divisions of some unscrupulous funds have been known to misrepresent earnings reports in order to make a fund seem more attractive to potential investors.  This is done by sinking capital into risky companies, “temporarily” waiving expense ratios, inflating yields by feeding principals (the amount you originally invested) back to shareholders at the expense of long-term returns, as well as a host of other misleading practices.

For the novice investor, it is of the utmost importance to only deal with the most reputable of bond fund providers, in order to avoid the tricks and traps employed by unethical financiers.  Furthermore, it doesn’t matter if you invest in bond funds with taxable yields if you invest through a retirement account! (I explain the benefits of investing through tax-sheltered retirement accounts in Section V.Table 3 below provides a glimpse at the average net returns for an initial principal of $10,000, as if invested in three term-different bond funds, from 2003 – 2013.  You’ll see the Vanguard funds that were used for this table again in Section VII, when I list a few highly respected mutual funds that you may want to consider when you are ready to invest.

TABLE 3: Comparison of a $10,000 Principal, as if Invested in Three Term-Different Vanguard Bond Funds, Over a Period of Ten Years

Short-Term (VFSTX)
Intermediate-Term (VFIIX)
Long-Term (VWESX)
1 yr
5 yr
10 yr

*Average net interest rate yields for these funds over the past ten yrs. are as follows: (VFSTX), 3.40%; (VFIIX) 4.48%; (VWESX) 6.02% **Source: vanguard.com (2013 Oct 4) *** See Section IV for more on compounded interest calculations

Money Market Funds

Money Market Funds are really just glorified checking accounts!  They are used by investors primarily as a place to stash emergency capital (e.g., for use in times of unexpected hardship caused from something like unemployment or losing a job or a fire resulting in property loss, an impatient bookie to whom you owe money … you get the idea) or as a place to park money awaiting investment.  Each share in a money market fund is worth one dollar.  When an investor decides which securities he or she would like to purchase, these money market shares — of one dollar apiece — are swapped out (electronically) for cash in order to buy those securities.  The upswing to money market funds over most checking and savings accounts is that your money earns a higher rate of interest.

These funds are a great place to park some spare cash in case of emergencies, or to set aside funds for an upcoming purchase (e.g., a new home, your kid’s braces, a motorcycle).  In fact, money market accounts may even be used as a part of your investment strategy.  For example, if you have your eye on an attractive security, but notice that it’s currently overpriced (see the next section to learn how to determine if an investment security is overpriced), you can place the funds in a money market account while you wait for prices to even out.

Some folks are wary about placing their savings in money market accounts, because they suspect these funds of being somehow related to all of that “risky stock market business.”  In fact, thanks to federal regulations, money market funds are only allowed to invest in securities with the highest credit ratings, and their holdings must have an average term maturity of no more than 90 days.  Also, did you know that large banks are only required to keep ten cents on the dollar in-house for every dollar that you entrust to them for safekeeping?  Moderately sized banks are only required to keep three cents on the dollar available, and some smaller banks aren’t required to hold anything in reserve!On the other hand, it should comfort you to know that every dollar you invest in mutual funds — whether they be stock, bond, hybrid, or money market — corresponds proportionately to the fund’s securities and/or cash holdings. For this reason, it can be said that banks are more likely to fail than most reputable money market accounts!

In a Nutshell: Most Common Types of Mutual Funds

Starting to get your bearings, right? Read on to increase you knowledge even more about mutual fund investing!
  • Stock Funds- Also called equity funds, the assets for these funds are primarily invested through the stock market. They may come in growth or value incarnations, or some combination of the two (“blend” funds).
  • Bond Funds- Assets for these funds are invested through the bond market. You will see bond funds that focus on short-term, intermediate-term, and long-term bonds, or some combination of the three.
  • Money Market Funds- Consistently priced at $1/share, these funds are really glorified checking accounts with higher interest yields than you would find at most banks.
  • Hybrid Funds- A combination of two or more types of funds, generally stock funds and/or bond funds. If you understand these other mutual fund classes, then you can grasp the concept of hybrid funds.
The best mutual funds are easy to spot if you know what to look for — they’re a lot like the lead runners in a marathon!

Identifying the Best Mutual Funds


In the last section, we talked about the most popular types of mutual funds that are available to investors (i.e., stock funds, bond funds, hybrid funds and money market funds), touched on the importance of selecting mutual funds from reputable companies, and I even waxed philosophical about the dissimilarities between fund managers and Henry VIII!  Now, it’s time to learn how to identify the best mutual funds from the rest, and we’ll discuss some solid and easily measurable criteria to help you assess whether or not a fund is worth your time and money.

Specifically, there are several important factors to take into consideration when choosing mutual funds.  These considerations include fund performance over time, the actual experience level of the fund manager, the reputation of the fund’s parent company, and several components of — arguably — the single greatest determinant: the total “cost” of the fund.  This does not simply mean the share price, but rather all of the costs associated with purchasing and maintaining your mutual fund shares.  The best funds minimize these associated costs as much as possible, and there is no exception to this rule — no matter what commission driven brokers and network contracted talking heads may say to the contrary!  I list some highly respected funds by company in Section VII that will give you an idea of what to look out for in terms of a fund’s reputation and performance, but we’ll focus on assessing the total cost of a fund in this section.

You will want to look at three types of costs associated with purchasing and maintaining a mutual fund, before deciding whether or not to add it to your portfolio.  These are the price-to-earnings (P/E) ratio, sales loads and the total fund operating expenses.  Let’s discuss each one in detail:

P/E Ratio

The price-to-earnings (P/E) ratio is what you will look at to determine whether or not a mutual fund currently has a share price that is undervalued, is evenly priced, or is overvalued in relation to the market.  For individual stocks, it is the ratio between a fund’s price per share and earnings per share.  For mutual funds, the P/E ratio is generally the weighted average of all of the P/E ratios for the securities that the fund is invested in.

Now, don’t worry: you do not need to understand all of the calculations that go into determining a mutual fund’s P/E ratio in order to make use of this figure!  Many free online market tracking websites provide detailed information, including P/E ratios, for most mutual funds.  For instance, Google Finance and MSN Money are great resources for researching this kind of info.

Just remember a simple rule-of-thumb: if a fund’s P/E ratio is much greater than 15, then it’s share price is overvalued in relation to the Market.  This could be because the fund is currently investing in riskier, high-growth businesses in order to rapidly increase profits.  There’s nothing wrong with this strategy, per se, but the trade-off is that rapidly increasing profits can rapidly turn into losses if the Market takes a turn for the worse.  Moreover, such aggressive funds tend to rack up higher trading costs, which can also eat into profits (more on this a bit later).

Personally, I tend to think that buying mutual fund shares that are overvalued is wasteful, and may be likened to getting overcharged by an unscrupulous mechanic for work done on your automobile.  Furthermore — as discussed in the previous section — many aggressive growth funds also happen to be “actively traded” funds, and very few of these consistently outperform solid index funds that focus on comparable industries.  There are some exceptions to this rule, and if you are planning on letting your money grow for an extended period of time (i.e., longer than five years) then the effects of higher P/E ratios are less pronounced.

On the other hand, if a fund’s P/E ratio is much lower than 15, then the share price is undervalued, and there may be an opportunity to purchase more shares at a discount.  Finally, a P/E ratio which sits squarely at 15 implies that a mutual fund is being sold at a price that is equal to its actual “market worth.”5

Fun Facts: Mutual Funds Make Money for Shareholders in Three Ways

  • Appreciation- Increased fund share price over time
  • Dividends- Profits paid to the fund from ownership securities that are dispersed among shareholders
  • Capital Gains- Profits earned when fund managers sell fund holdings (e.g., stocks, bonds, commodities) for more than they paid for them

Remember!  To reap the benefits of stock market growth over time, it is necessary to reinvest profits made by dividends and capital gains into purchasing more shares of the fund.  In this way, investor’s are able to maximize their earnings from compounded interest. (The return tables in this tutorial all assume that dividends and capital gains have been entirely reinvested — throughout ownership of the fund — for the time periods considered.)

Sales Loads

I’m going to make this simple —

When you encounter a mutual fund that carries with it any type of sales load, run (don’t walk) away from that fund!  Sales loads are completely unnecessary, are designed to bilk investors out of their hard-earned money, hurt returns and are easily avoided by choosing among the many no-load (N-L) mutual funds available.

There are several varieties of sales loads that investors should be on the lookout for.  The first are front-end loads, which are deducted from a person’s initial investment when buying fund shares, in order to pay brokers who sell the security.  Essentially, these charges are a “finders fee,” and are paid as thanks (out of the investor’s — not the mutual fund company’s — pockets) to brokers for bringing business to a particular fund.  They typically range from four to eight percent of the principal investment.

Buying into mutual funds with sales loads is like being victimized by a pickpocket!

Similarly, back-end loads are fees that are taken out of the investor’s wallet to pay brokers a commission when fund shares are sold.  Some funds attempt to use deceptive language when advertising, in order to trick investor’s into buying shares of a fund with loads, by classifying the shares into different “categories”. For example, Mutual Fund X will tell you that if you buy shares of variety A rather than shares of variety B, and then hold those shares for a pre-determined amount of time, you will be exempt from sales loads when you decide to sell the shares.

But, don’t buy it (literally)!  Funds that attempt to mislead you using these kinds of tactics will invariably charge investors more through higher operating expenses (covered below), miscellaneous fees or some other such nonsense.  Once an unscrupulous broker or mutual fund management team decides to hustle money away from investors using unnecessary fees, you can be sure they will find a way to get that money, regardless of the type of shares bought and how long they are held.

On that note, perhaps the most offensive fee charged by some mutual funds is known as the 12b-1 fee.  This ambiguously named fee basically amounts to money being taken from unassuming fund shareholders in order to pay for “advertising costs”.  Thankfully, the overall upward trend of personal investor education in recent years has shined a light on this dirty little fee, and many people now know to stay away from the funds that charge it.  With any luck, mutual fund companies will simply discontinue the fee in years to come.  Still, if you encounter a fund that is still levying the infamous 12b-1 on its beleaguered shareholders, you may safely deduce that the fund is not worth your time.

Similar to the P/E ratio, information about a fund’s fee schedule may be found through its information page on free financial websites, as well as in the fund’s prospectus.

Fun Facts: Loaded Funds Vs. N-L Funds & Bull/Bear Markets

  • The sad truth is that the majority of mutual funds with sales loads get outperformed by no-load mutual funds!
  • A Bull Market is associated with increased (investor) confidence and overall investing, in anticipation of market share price increases.  A Bear Market indicates a general decline in the stock market, and share prices over time (at least 20% over two months).  It is a period of pessimism and investment anxiety.

Total Fund Operating Expenses

Mutual funds, like any business, have operating expenses.  Fund managers and research assistants draw a salary, rent and utilities at the fund’s office building must be paid, food and water — I suppose — must be provided for the interns, etc.  Generally speaking, businesses that minimize expenses and maximize profits are better positioned to enjoy success than businesses that do not. This is also true for mutual funds.

As such, a good stock fund will charge shareholders an annual expense rate of around 1%.  The very best will only deduct a fraction of a percent!  Bond funds can get away with charging slightly less than stock funds — about .5%/yr. is reasonable — in total operating expenses, due in part to the lower turnover rate in a typical bond fund’s holdings as compared to a typical stock fund.  Money market fund expense ratios really have no business getting much higher than .333%, and if you find one that greatly exceeds this generous estimate, politely (or impolitely — it’s your call) decline to buy shares in the fund.  As with P/E ratios and fee schedules, total fund operating expenses (sometimes called expense ratios) for a fund may be found on free financial websites and the fund’s prospectus.

In a Nutshell: Keep Costs down and Only Consider Respectable Mutual Funds

Nearly there — Soon you’ll be navigating the ins and outs of mutual fund investing like a pro!

Distinguishing between good and bad mutual funds means knowing how to analyze the fee schedule for any fund you may be interested in.  Specifically, keep an eye on P/E ratios, whether or not the fund comes attached with sales loads and total fund operating expenses.  (Check out Table 4 below to get an idea of how high fees impacts the ability of your principal to earn over time.)  

Also, remember that reputation is important!  When choosing a mutual fund provider, keep in mind that companies like ‘The Vanguard Group’ and ‘Fidelity’ are some of the most respected and time-tested providers of funds in the business.  Start-up companies with names like ‘Bob’s Fly-by-Night Mutual Funds’ probably shouldn’t inspire the same level of confidence. (I list some established mutual fund companies in Section VI of this series, as well as some of the top mutual funds in the country in Section VII.)

TABLE 4: Comparison of a $10,000 investment, with a ten percent return (compounded annually), across two funds with different fee schedules

Fee Schedule
Fund A
Fund B
Combined Sales Loads (4% of Principal)
12b-1 Fee
Total Fund Operating Expenses
Total Return (1 yr):
Total Return (5 yr):
Total Return (10 yrs):

A 3% annual fee on your investment, combined with a $400 sales charge may not seem like much out of ten grand, but — as you can see — it really adds up! *I’ll explain the formula for compounded interest calculations in Section IV.

Mutual Fund Asset Allocation Formula (by Age & Risk Tolerance)


Time to slice up the pie — of your mutual fund portfolio!

So far, we’ve defined and categorized mutual funds in plain English, staying far away from that derivative of ancient Greek that Wall Street insiders seem so often to converse in!  Additionally, we have learned some easily measurable criteria to assess whether a mutual fund is worth your hard-earned investment capital.  In this section, I’ll show you a simple mutual fund asset allocation formula based on your age and risk tolerance.

To begin, the decision about how your mutual fund investment “pie” should be sliced up will depend on your financial goals (and the timeline that you have in mind for meeting them), as well as your overall tolerance for risk. With greater risk comes the potential for greater rewards, but — as every mutual fund prospectus is required to tell you — past performance is no guarantee of future results.  For example, even though the stock market has historically averaged a return rate of about 10%/yr., there is no guarantee that it will continue to do so.  (After all, a meteor could come hurtling through Earth’s atmosphere and crash into the New York Stock Exchange before Bruce Willis and Ben Affleck can formulate an appropriate response!  … However, if this happens, a mutual fund portfolio will likely be the least of your problems.)

As touched on in Section II, one way to protect yourself from wild market fluctuations is to adequately diversify your stock portfolio.  Additionally, another method of diversification employed by investors is to spread out investment dollars over inversely related market sectors.  That way, if one sector should take a nosedive in value, the losses will be offset by another on the rise.  The stock and bond markets have a tendency to move in such a fashion, and as a result many investors offset their stock holdings with bond holdings, and vice versa, in an attempt to hedge their bets.

Stocks are considered to be more volatile than many types of bonds — and likewise for the mutual funds corresponding to these market sectors — but the potential for returns on stock investments are much higher than what may usually be expected from bonds.  Therefore, a person’s tolerance for risk, financial goals, and expected investment time frame should all be considered before any decisions are made on how to slice up his or her investment pie.  For instance, the longer a person intends to hold stocks, the longer those stocks have to weather down markets and take advantage of up markets, thereby earning a decent return.

So if a person intends to stay in the market for ten years or longer, he or she would want to invest more heavily in stocks than bonds.  Contrarily, if someone will have need of investment dollars in under five years, then it makes sense to invest more heavily in (conservative) bonds, to protect against unfavorable market swings.  Table 5 details a simple formula for divvying up your assets between stock and bond mutual funds, based on your age and risk tolerance.

TABLE 5: Formula for (Retirement Planning) Asset Allocation

Risk Tolerance
% of Bond Holdings
% of Stock Holdings
Equal to Your Age
100 – Your Age
Somewhere in Between
Equal to Your Age – 10
110 – Your Age
Equal to Your Age – 20
120 – Your Age

Fun Facts: Compound Interest

Compound interest occurs when interest earned is combined with the principal investment, so that the new total replaces the original principal, and subsequently begins earning interest.  For example, if a principal of $10,000 is invested in a security that yields 10% in compounded interest per year, then the new principal becomes: $10,000 + $1,000 = $11,000. (Now $11,000 — i.e., the “new” principal — will earn 10% interest over the course of the second year, and at the end of that year the interest earned will be combined with the $11,000 to create yet another new principal, which will in turn earn ten percent interest during the course of the third year, etc.)

The formula used to calculate compounded interest, is:

A = P[1 + (r/n)]nt

(A = The answer; P = Principal; r = Interest rate; n = times compounded per year; t = Number of years)

Investing for Retirement


With failing confidence in our (U.S.) government, uncertainty over the future of Social Security, unscrupulous pension plan corruption from major companies and record breaking increases in the cost-of-living, it makes sense to start putting a little away for retirement sooner rather than later.  Investing the money that you have been saving up for your twilight years (at a level of risk that you are comfortable with, as discussed in Section IV) is a great way to let your money grow so that you can meet your financial goals.  After all, you want to be able to spend as much time as you please napping in your backyard hammock, rather than greeting people at Wal-Mart.

Edwin Booth, as quoted during a production of the lesser known — though, arguably just as important — Shakespearean masterpiece: ‘Hamlet … on Wall Street!’

Many people have misconceptions about what retirement vehicles like IRA and 401(k) plans are exactly, so I will attempt to clear it up here as concisely as possible:

Retirement accounts (like IRAs and 401(k)s) are not investment securities!  Rather, they are shells that protect the securities that you choose to invest in (like the mutual funds discussed in this article) from taxation.  Generally speaking, all of the money that you invest — in whatever securities your little heart desires — that are classified as falling under the shell of your “retirement” portfolio will grow un-taxed until you decide to cash in.

However, the rub is that if you try to withdraw money earned from investments that have been designated in this way before you have reached retirement age, then you are slapped with hefty fees in addition to the regular taxes that you are then expected to pay.  There are a few exceptions to those rules.  For instance, if you need to come up with some extra scratch in order to finance a necessary expenditure (like buying your first home), you are allowed to remove up to $10,000 from an IRA as long as it is replenished within a certain amount of time.

Also, different kinds of retirement plans handle taxation in different ways.  One such example is a Roth IRA, which is a shell for investments where taxes are paid up front, then deferred at the time of withdrawal.  This makes sense for people who plan to be in a higher tax bracket at the time of retirement.

401(k) plans are like IRAs that are provided by companies for their employees.  As an added bonus, the companies will actually match contributions that you make (up to a certain percentage) each time that you invest!  If your employer offers a 401(k) plan, then you really ought to take them up on it. (Why pass up free money?) You can also have other, separate retirement plans to round out your plan’s portfolio.  Even better, if you change jobs you can roll over your existing 401(k) to a 401(k) offered by your new employer.

Frankly, if you do enjoy keeping more of your money, and you don’t enjoy paying taxes, then there really aren’t many arguments to be made for not taking advantage of tax-sheltered retirement accounts! In addition to 401(k) plans that are offered by many employers, you may ask whatever mutual fund provider and/or brokerage you decide to go with to designate (at least one of) your accounts with them as an IRA account.  Check out Table 6 for an alphabetical listing of some reputable mutual fund providers. (Mutual fund providers and brokerages are discussed in the next section.)

Table 6: (Alphabetical) Listing of Some Respected Mutual Fund Companies

American Century
Artisan Funds
Cohen and Steers Realty
Dodge & Cox
Fidelity Funds
Harbor Funds
Masters’ Select Funds
Neuberger and Berman Funds
T. Rowe Price Funds
Tweedy Browne Funds
USAA Funds
The Vanguard Group

Choosing a Mutual Fund Company and/or Brokerage Firm


This article was written for an audience that has little to no interest in learning more than is absolutely necessary about mutual funds in order to start investing in them.  If such is still the case for you, then I recommend forgoing a brokerage altogether and purchasing your mutual funds directly from the parent company.  Websites for some of the most respected companies may be found in Table 5, above.

However, if this article has inspired you to wade deeper into the alluringly blue waters of the investment ocean, or if you would like to own mutual funds from several different parent companies simultaneously, then allow me to point you towards my tutorial on evaluating and selecting an online brokerage firm: Find the Best Online Brokerage Firms for Your Investment Strategy.  I have also placed a short list of some popular online brokerages in Table 7. (If you want to get serious about investing, then you will need a good brokerage to serve as a springboard to — and base of operations for — all of your forthcoming investment activities.)

TABLE 7: (Alphabetical) Listing of Some Popular Online Brokerages

Charles Schwab
Interactive Brokers
Muriel Siebert
TD Ameritrade
T. Rowe Price

A List of Some Great Mutual Funds (by Category)


In this section, I’ll list some of the most respected mutual funds in the country by category, so that you will have a basis for comparison for any funds you may be interested in.  Within each respective category, different funds are separated by commas after provider names:

U.S. Stock Funds:

  • American Century – Income, Growth
  • Dodge & Cox – Stock
  • Fidelity – Disciplined Equity, Equity-Income, Fidelity Low Priced Stock
  • Masters’ Select – Equity, Smaller Companies, Value
  • Neuberger and Berman – Focus
  • T. Rowe Price – Spectrum Growth (has some foreign holdings)
  • Vanguard – Total Stock Market Index, Primecap, S&P 500 Index, Tax-Managed Capital Appreciation, Tax-Managed Small Capitalization

International Stock Funds:

  • Artisan – International
  • Fidelity – Diversified International
  • Harbor – International
  • Masters’ Select – International Equity
  • Oakmark – International and Global (has some U.S. holdings)
  • TIAA-CREF – International Equity
  • Tweedy Browne – Global Value (has U.S. holdings)
  • Vanguard – International Growth, Tax-Managed International, Total International Stock Index

Bond Funds:


  • Vanguard – Short-Term Investment Grade Portfolio, Short-Term Tax Exempt, Limited-Term Tax Exempt


  • Dodge and Cox – Income
  • Harbor – Bond
  • Vanguard – GNMA, High-Yield Corporate, Total Bond Market Index


  • Vanguard – Long-Term Investment Grade Bond Fund

Hybrid Funds:

  • Dodge and Cox – Balanced
  • Fidelity – Asset Manager, Freedom Funds, and Fidelity Puritan
  • TIAA-CREF – Managed Allocation
  • T. Rowe Price – Balanced
  • Vanguard – LifeStrategy Funds, Wellesley Income, Wellington

Money Market Funds

  • Vanguard – Prime Money Market
  • Fidelity – Cash Reserves, Spartan Money Market (higher yields after $20,000)
  • T. Rowe Price – Summit Cash Reserves (higher yields after $25,000)

Investor Education Websites & Financial Newsletters


  •  Barron’s– Founded in 1921, Barron’s is a weekly American financial newspaper. Each edition offers an analysis of the previous week’s market activity, as well as predictive reports and commentary on the week to come.
  • Special Situation Surveyby Forbes Newsletters- You’ve undoubtedly heard about Forbes’ “Richest Americans” list, but did you know that the company’s Special Situation Survey has been around since 1954?  This publication is one of the oldest continuously published investment newsletters on the market.  Subscribers receive a monthly 10-page research report recommending just one undervalued stock that Forbes analysts believe will soar within one to two years, based on thorough fundamental analysis.  The SSS is a great newsletter for new casual investors who wish to become more active in the stock market to get their feet wet with, without becoming overwhelmed with technical information about many companies at once. (Note: the above is an affiliate link.) 
  • Kiplinger’s– This is a personal finance magazine that has been around since 1947, so they must be doing something right!
  • Morningstar– An excellent resource for mutual fund research.
  • SEC– The Securities and Exchange Commission has the skinny on all of the publicly traded companies in America. (They’re also the guys who took Charlie Sheen away in handcuffs at the end of Wall Street.)
  • Valueline– An outstanding stock analysis service. You may even be able to find back issues at your public library, for free (barring late charges)!
  • The Vanguard Group– In addition to offering online brokerage services and a stellar family of mutual funds, Vanguard also hosts an outstanding free learning center.
  • The Wall Street Journal– “TWSJ” has been around since the 1800s. Every self-respecting stock broker has a subscription to this iconic publication.

In a Nutshell: Parting Wisdom

We’ve reached the finish line! You should now know everything you need to know to start investing in mutual funds like a Wall Street insider. I hope you see a whole lotta blue sky and sweet, sweet green (money, that is) in the future!

Remember to buy and hold your investments for the long haul, to keep down trading costs and maximize profits.  Do not purchase shares in stock mutual funds that you plan to hold for less than five years, at a minimum. Preferably, you should maintain your positions for ten years or longer.

Be disciplined, and don’t panic during market slumps.  If anything, consider purchasing more shares when one or more of your mutual fund’s share prices drops in a down market!

Also, Remember to diversify your mutual fund portfolio by investing across a variety of sectors, to protect yourself from market fluctuations. Like Mom always says: “Don’t put all your eggs in one basket!”

For example, the stock and bond markets tend to move in opposite directions. Hedge your bets by offsetting your holdings between these two antagonistic sectors.

Well friends, that’s it for now.  So, what are you waiting for?  Get your hard-earned savings into some high quality mutual funds, and start letting your money work for you for a change!

Other Personal Finance Tutorials

If you enjoyed reading this, check out some of my related work listed above!  You might also consider following me on Twitter (@EarlNoahBernsby) and Facebook, to receive notification the moment I publish a new article.  Additionally, you can show support simply by bookmarking this page, and/or by clicking Facebook and Twitter’s ‘Like’ and ‘Tweet’ icons seen at the beginning and end of this article!



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  2. Barrington, R. Online banks offer best savings account rates for 2013 [Internet]. New York, NY: Forbes; 2013 Jan 1, [cited 2013 Oct 4]. Available from: http://www.forbes.com/sites/moneybuilder/2013/01/11/online-banks-offer-best-savings-account-rates-for-2013/
  3. The case for index fund investing [Internet]. [Place unknown]: The Vanguard Group; 2013 Apr, [cited 2013 Oct 4]. Available from: https://personal.vanguard.com/pdf/s296.pdf
  4. Reserve Requirements [Internet]. Washington, D.C.: The Federal Reserve; 2013 Nov 5 [cited 2013 Dec 23]. Available from: http://www.federalreserve.gov/monetarypolicy/reservereq.htm
  5. P/e ratio [Internet]. Alexandria, VA: The Motley Fool; [cited 2013 Oct 4]. Available from: http://wiki.fool.com/P/e_ratio

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 PerraultCC0 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: FBellonCC-BY 2.0, via Flickr. 2011 Nov 6 [cited 2014 Feb 28]. Available 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
  6. ‘Henry VIII.’ Source: Original Painting by Hans Eworth, Public Domain (i.e., Author has been deceased for more than seventy years: see Article 6.i. under UK Copyright Law.), via Wikimedia Commons. Circa 1520-74?. Derivative art by E.N.B. Original photo available from: http://commons.wikimedia.org/wiki/File:Henry_VIII_Chatsworth.jpg
  7. ‘S&P 500 Closing Values (1950-2012) along with 1, 2 and 3 year moving averages.’ Source: Mogrifier5, CC-BY-3.0, via Wikimedia Commons. 2013 Jan 21. Available from: http://commons.wikimedia.org/wiki/File:S%26P500_(1950-12).jpg
  8. ‘Sign on Wall Street captured as background light creates a shading effect.’ Source: Galaksiafervojo, CC-BY-2.5, via Wikimedia Commons. 2005 Dec 9. Available from: http://commons.wikimedia.org/wiki/File:Wall_St_Sign.JPG
  9. Participants near the end of the 26-mile course at the 29th annual Marine Corps Marathon, in Washington, D.C. Source: Journalist 1st Class Monica Darby, Public Domain (i.e., This photo is a U.S. Government work and is not subject to copyright: learn more.), via Wikimedia Commons. 31 Oct 2004. Available from: http://commons.wikimedia.org/wiki/File:USMC_Marathon.jpg
  10. ‘Pickpocket Macro.’ Source: Steven Depolo, CC-BY 2.0, via Flickr. 2010 May 24 [cited 2014 Feb 28]. Available from: http://www.flickr.com/photos/stevendepolo/4637904620/
  11. ‘The corner of Wall St. and Broadway, showing the limestone facade of One Wall Street in the background.’ Source: Fletcher6, CC-BY-SA-3.0, via Wikimedia Commons. 2008 Sep 13. Available from: http://commons.wikimedia.org/wiki/File:Wall_Street_%26_Broadway.JPG
  12. ‘Cherry Walker nee Leach in a Maxam Baked Pastry advertisement.’ Source: Harry Poulsen, Public Domain (i.e., This photo was taken in Australia prior to 1955 Jan 1: learn more from the .pdf, Photographers & Copyright, published by the Australian Copyright Council.), via Wikimedia Commons. Circa 1951. Available from: http://commons.wikimedia.org/wiki/File:StateLibQld_1_198311_Maxam_Bakeo_advertisement,_1951.jpg
  13. ‘American actor Edwin Booth as William Shakespeare’s Hamlet.’ Source: Original Photo by J. Gurney & amp; Son, N.Y, Public Domain (i.e., This photo was taken in the U.S. prior to 1923: learn more.), via Wikimedia Commons. Circa 1870. Derivative photo by E.N.B. Original photo available from: http://commons.wikimedia.org/wiki/File:Edwin_Booth_Hamlet_1870.jpg
  14. ‘Sign indicating 1-22 Wall St. and Broadway crossing, with a brilliant blue sky in the background.’ Source: Benoît Prieur, CC-BY-SA-3.0, via Wikimedia Commons. 2011 Mar 5. Available from: http://commons.wikimedia.org/wiki/File:Sign_Brodway_crossing_Wall_Street.JPG

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