Investing in Mutual Funds 101: How to Make Money

How do you make money investing in mutual funds? There are basically two ways to make money and two ways to lose money when investing in mutual funds. Let’s get to the basics.

There are thousands of funds to choose from, and the vast majority of them fall into one of four categories based on where they invest money (your money). They are called: equities (shares), bonds, money market funds and mixed funds. In all of this, you open an account, invest money and use it to buy shares. You make money when you invest based on the number of shares you own. The same applies if you lose money while investing.

Let’s start with the most popular and risky category called STOCK FUNDS that invest money in stocks, also known as “stocks”. Why invest money here? The primary goal is growth, dividend income as a secondary goal. You make money by investing here when the stock price goes up and on dividends. You lose money when the stock price falls. The dividends come from the stocks in the fund’s portfolio and are passed on to you. They (like all dividends) are yours. The main attraction of equity funds: the potential for high returns.

BOND FUNDS have one primary goal: higher returns in the form of dividends. Also called INCOME FUNDS, they are generally safer than the stock variety. You invest money here to earn higher dividends than you can get anywhere else. The dividends come from the interest income of the fund’s bond portfolio. You can also make money when the stock price goes up; and lose money when the stock price falls. There is usually significantly less price volatility than in the stock or stock category.

BALANCED FUNDS are a happy medium between the above two as they invest money in both stocks and bonds. Therefore, you make money from both rising stock prices and dividends, and you lose money investing when stock prices fall. Here you have a moderate risk.

Money market funds are the safe bet and there is only one way to make money by investing in them: dividends. You invest money and earn interest in high-quality, short-dated (money market) bonds. They pass this interest on to you in the form of dividends. The stock price is pegged to $1 and does not fluctuate. Very rarely do investors lose money investing here.

Most people invest money in mutual funds as a long-term investment. So in most cases, they simply allow the fund company to reinvest any dividends (and other distributions) to buy more shares. Distributions (like capital gains from the sale of shares) are somewhat technical. Don’t worry – if you come, you’ll get your share. You will also receive periodic account statements showing activity on your account.

In the beginning we said that there are basically two ways to make money and two ways to lose money by investing in mutual funds. What is the second way to lose money? Let me give you an example, and as a former financial planner, I’ve seen this time and time again. Joe Blow decided to invest money in mutual funds through a “financial planner” (not me). He put $20,000 into a mutual fund and about a year later he looked at his last statement and it showed a total of $19,000.

The stock market showed a modest gain this year. How did he lose money while investing? Answer: $1000 was deducted above to pay for referral fees known as “Loads”. About $300 went towards annual expenses and another $300 towards additional fees. Joe claims that he knew nothing about these fees and charges.

There is no need to pay big bucks when investing money in mutual funds. Had Joe gone with NO-LOAD funds, he could have spent a total of about $200 a year investing. You can make money by investing in mutual funds as a long-term investment. Just don’t work against yourself by losing money to high fees and charges.