The Best Mutual Funds and How to Start Investing

Mutual funds are a type of investment that pools together money from many investors, then uses that money to invest in a variety of stocks, bonds or other assets. They can help diversify your portfolio, since you could gain exposure to hundreds of investments all in one.

Mutual funds are often the foundation of many investment accounts, particularly retirement accounts such as 401(k)s. You can invest in mutual funds via a brokerage account, retirement account or sometimes even directly from a mutual fund company.

No matter which category a mutual fund falls into, its fees and performance will depend on whether it is actively or passively managed. Passively managed funds invest according to a set strategy. They try to match the performance of a specific market index, and therefore require little investment skill or professional management. Given that, they will carry lower fees than actively managed funds.

Actively managed funds have a fund manager or team making decisions about how to invest the fund’s money, so they typically charge higher fees. Often they try to outperform the market or a benchmark index, but studies have shown passive investing strategies often deliver better returns.

Simplicity: Once you find a mutual fund with a good record, you have a relatively small role to play. The fund managers do all the heavy lifting of selecting and rebalancing investments.

Low costs: Investing costs have come down, and that extends to mutual funds. Mutual funds can be an inexpensive way to hold many investments at once.

Diversification: Mutual funds provide access to a large selection of investments without the difficulties of having to purchase and monitor dozens of individual assets yourself.

Brokerage firms
on Charles Schwab’s website	on E*TRADE’s website
on Vanguard’s website	on Fidelity’s website

If you’re ready to invest in mutual funds, here’s our five-step guide on how to buy them.

Your first choice is perhaps the biggest: Do you want to beat the market or try to mimic it? It’s also a fairly easy choice: One approach costs more than the other, often without delivering better results.

Actively managed funds are managed by professionals who research what’s out there and buy with an eye toward beating the market. While some fund managers might achieve this in the short term, it has proved difficult to outperform the market over the long term and on a regular basis.

Thinking about your budget in two ways can help determine how to proceed.

How much do mutual funds cost?

One appealing thing about mutual funds is that once you meet the minimum investment amount, you can often choose how much money you’d like to invest. Many mutual fund minimums range from $500 to $3,000, though some are in the $100 range, and there are a few that have a $0 minimum. Aside from the required initial investment, ask yourself how much money you have to comfortably invest, and then choose an amount.

Which mutual funds should you invest in?

Maybe you’ve decided to invest in mutual funds but aren’t sure what initial mix of funds is right for you. Generally speaking, the closer you are to retirement age, the more holdings in conservative investments you may want to have — younger investors typically have more time to ride out riskier assets and the inevitable downturns that happen in the market. One kind of mutual fund takes the guesswork out of the “what’s my mix” question: target-date funds, which automatically reallocate your asset mix as you age.

You need a brokerage account when investing in stocks, but you have a few options with mutual funds. If you contribute to an employer-sponsored retirement account, such as a 401(k), there’s a good chance you’re already invested in mutual funds.

You could buy directly from the company that created the fund, but doing so will limit your choice of funds. You can also work with a traditional financial advisor to purchase funds, but it may incur some additional fees.

Most investors opt to buy mutual funds through an online brokerage, many of which offer a broad selection of funds across a range of fund companies. If you go with a broker, you’ll want to consider:

A fund’s expense ratio isn’t always easy to identify upfront (you may have to dig through a fund’s prospectus to find it), but it’s well worth the effort since these fees can eat into your returns over time.

Mutual funds come in different structures that can impact costs:

Whether or not funds carry commissions is expressed by “loads,” such as:

Once you determine the mutual funds you want to buy, you’ll want to think about how to manage your investment.

One move would be to rebalance your portfolio once a year, with the goal of keeping it in line with your diversification plan. For example, if one slice of your investments had great gains and now constitutes a bigger share of the pie, you might consider selling off some of the gains and investing in another slice to regain balance.

Sticking to your plan will also keep you from chasing performance. This is a risk for fund investors (and stock pickers) who want to get in on a fund after reading how well it did last year. But “past performance is no guarantee of future performance” is an investing cliche for a reason. It doesn’t mean you should just stay put in a fund for life, but chasing performance almost never works out.

To determine the best mutual funds measured by five-year returns, we looked at U.S. equity funds open to new investors with low costs (expense ratios of 1% or less) and minimum investment requirements of $3,000 or less.

Managing your portfolio also means managing your expectations, and different types of mutual funds should bring different expectations for returns.

Stock mutual funds, also known as equity mutual funds, carry the highest potential rewards, but also higher inherent risks — and different categories of stock mutual funds carry different risks.

For example, the performance of large-cap, high-growth funds is typically more volatile than, say, stock index funds that seek only to match the returns of a benchmark index like the S&P 500.

Bond mutual funds, as the name suggests, invest in a range of bonds and provide a more stable rate of return than stock funds. As a result, potential average returns are lower.

Bond investors buy government and corporate debt for a set repayment period and interest rate. While no one can predict future stock market returns, bonds are considered a safer investment as governments and companies typically pay back their debt (unless either goes bust).

These are fixed-income mutual funds that invest in top-quality, short-term debt. They are considered one of the safest investments you can make. Money market funds are used by investors who want to protect their retirement savings but still earn some interest — potentially between 1% and 5% per year.

Chasing past performance may be a natural instinct, but it often isn’t the right one when placing bets on your financial future. Mutual funds are the cornerstone of buy-and-hold and other retirement investment strategies.

Likewise, chasing one-year returns is not a wise investment strategy. You’ll want to look for consistency of returns on a longer time horizon and consider what role a specific fund will play in your portfolio.

You can create a smart, diversified portfolio with just a few well-chosen mutual funds or ETFs, plus annual check-ins to fine-tune your investment mix.