A quick guide for moving into mutual funds

By Michele Lerner

Like many people, the recession encouraged me to take a harder line with my budget. I'm definitely saving more and being more careful with spending.�� But I'm also looking past just saving the money I already have -- I'm looking into earning it.

This morning, I checked on the interest rate on my emergency savings account, and it turned out to be less than 0.5 percent, much lower than I realized! As a result, my next financial move will be to shift some of those savings into a fund where the interest is higher. I decided to do some research, and thought it might be helpful to those foraying into this higher return territory.

From savings accounts to mutual funds

While your basic emergency savings should stay intact in a fund where the money can be accessed quickly when necessary, as soon as that savings account has reached your target comfort level it is time to move into slightly riskier territory to increase the return on your money.

Investors with a deep understanding of the stock market might feel ready to invest in individual stocks, but individuals who are new to the investment world tend to opt for a mutual fund. A mutual fund pools money from investors and builds a portfolio of investments within the fund, with the investors sharing in the gains or losses of the fund.

The main reason new investors opt for mutual funds, besides their professional management, is that

they often allow small investments of as little as few hundred dollars. Unlike a certificate of deposit with penalties for early withdrawal, mutual fund investors can also redeem their shares at any time.

What to watch out for

On the downside, investing in mutual funds usually requires the payment of fees or sales charges that cut into your profits. Working with a discount brokerage can reduce your fees, and if you take the time to find the best online broker you may be able avoid fees almost altogether.

For those of us used to our principal being FDIC-insured, it is important to know that mutual funds are not insured and can lose money. However, in general, these funds can be safer than buying individual stocks because they are professionally managed and diversified.

Types of mutual funds

While thousands of mutual funds are available for investors, there are three main categories:

1. Money market funds: relatively low risk investments because they can only invest in high-quality, short-term investments. But low-risk also means that the returns are somewhat low.
2. Bond funds: Bonds vary widely in their investment choice, so some are riskier than others. The safest invest in government bonds, while the riskiest are high-yield bond funds called junk bonds. Investing in municipal bond funds have the added benefit that they can help reduce your taxes.
3. Stock funds: Stock funds include growth funds that invest in stocks with potentially large capital gains; income funds that invest in stocks that pay dividends; index funds that invest in the stocks in a market index like the S&P 500; and sector funds that invest in a particular industry such as health care or consumer products.

Mutual funds: How do I find them?

Some mutual fund shares can be purchased directly from the fund, but most are sold through brokers, banks, financial planners or sometimes insurance agents. When choosing a broker, make sure you search for the best online brokers or best online banks that meet your needs. If you intend to stick to investing in mutual funds rather than trying your hand at buying and selling individual stocks, look for an investment company that offers a wide variety of mutual funds so that diversifying is easier.

One good option can be a brokerage such as Vanguard or Fidelity that offers a variety of funds within one company. Some of these brokerages will allow you to transfer your investment from one fund to another without paying a fee.

Make sure you check to see the fees associated with different mutual fund accounts you are considering. Try to find a fund with low fees so you don't lose too much of your investment to expenses. In addition, look for a "tax-efficient" fund so you don't get hit with a big tax bill on your dividends.

Taking the time to do a little bit of research into the reputation of various brokerages can go a long way to making your first dip into the mutual fund pool profitable.

Personal risk assessment

Once you have chosen a brokerage, you need to do some research (and perhaps a little soul-searching) about your comfort level with risk. If you have funded your emergency savings, you may be more comfortable taking some investment risks. In addition, your age should influence your willingness to take risks. Younger people have more time to recoup any losses than those nearing retirement age.

Whatever investment strategy you decide to go with, make sure to periodicaly reassess your investments, and make sure that they're working for you, not vice cersa.