Mutual Funds 101

Asset class: a group of securities that have similar characteristics and values that tend to move in the same direction as other securities of the same class. The main asset classes are equities (stocks), fixed-income investments (such as bonds) and cash equivalents (including short-term certificates of deposit and U.S. Treasury bills).

Diversification: a risk-management technique that involves spreading your savings around a large enough quantity and variety of investments so that a significant loss on any one investment or segment of your portfolio won’t produce a big loss relative to your entire portfolio.

Index: a barometer of a specified type of investment and a benchmark against which investment performance is measured. A widely known index is the S&P 500, which tracks the stocks of the 500 largest U.S. stocks measured by their market capitalization (share price times number of shares in the market).

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Mutual funds are a popular investment choice for many investors. Offering simplicity, diversification and the flexibility to redeem shares upon request, mutual funds can help investors build wealth and meet their short-term, medium-term and long-term financial goals.

A mutual fund is a pool of investments owned by many investors. These individuals put money into the fund, and the fund invests the money to produce capital gains and/or income for each investor’s fund account. The fund’s portfolio might be composed of anywhere from a few dozen to hundreds of different securities. To own a fund, you buy shares in it, and each share you own represents an interest in the entire pool of investments owned by the fund. Investors share in the gains and losses of fund investments.

How funds are categorized

Mutual funds are categorized in many different ways, and any one fund might fall under multiple categories. Below are some of the ways in which funds are most commonly grouped together.

  • By asset class. Many funds are categorized by the asset class they invest in the most, whether it’s equities (stocks), fixed-income investments (e.g., bonds), cash equivalents (including short-term certificates of deposit or U.S. Treasury bills), natural resources, precious metals, commodities (e.g., corn, wheat or soybeans), or real estate. Funds can be further divided into subcategories; for example, bond funds can be classified as either short-term or long-term bond funds, and equity funds can be either U.S. or international equity funds. Some funds aren’t easily identified by asset class because they invest in a variety of them without emphasizing any one in particular.
  • By investment objective. Funds try to achieve either capital appreciation (a rise in the value of assets), current income (typically in the form of ongoing dividends), or preservation of capital (minimizing a loss in the value of assets). Typically, stock funds have capital appreciation as a main objective and bond funds target current income. A fund can, however, have more than one objective. For example, a growth and income stock fund might have capital appreciation as a primary objective and current income from dividends as a secondary goal.
  • By investment technique. Some funds are identified by the technique or strategy they follow in pursuit of their objectives. For example, a lifestyle fund invests in a mix of asset classes to match a specific investor risk profile, typically defined in terms of the investor’s age, time horizon and risk-and-return objectives. The fund’s investment mix may or may not shift over time. Some stock funds focus on companies in a given industry, like biotechnology or retail, or geographic region, whether it’s the United States or countries outside our borders.
  • By whether they’re actively or passively managed. An actively managed fund’s investment manager regularly makes decisions on which securities to buy, sell or hold. A passively managed fund (also known as an index fund) is set up to minimize investing costs by matching the components and, therefore, mimicking the performance of a specified market index such as the S&P 500.

Benefits and risks of mutual funds

Mutual funds offer numerous advantages, including:

  • Diversification. Because each fund share you buy gives you part ownership of a portfolio of multiple securities, you get instant diversification, which reduces the risk of having too many eggs in one basket. You may get even more diversification by investing in multiple funds.
  • Professional management. Buying shares in an actively managed fund gives you access to a professionally managed, diversified portfolio that would be difficult to create on your own with a relatively small investment amount.
  • Modest investment amounts. Depending on fund rules, you might be able to open an account with a relatively modest investment, and the fund might also allow your subsequent contributions to be small. You can even set up automatic, ongoing investments through transfers of money from your bank account.
  • Ease of buying and selling. You might be able to buy shares directly from the fund or through an investment dealer or broker or financial institution. Just write a check for whatever amount you wish to invest or arrange to buy shares electronically through your bank account. Funds also offer daily liquidity; to sell shares, simply contact the fund in writing, over the phone or over the Internet or ask your dealer or broker to sell them for you.

Like all investments, mutual funds can pose a degree of risk. Maybe the fund’s investments will perform poorly. Perhaps the financial markets where the fund invests will slump due to economic, political or other factors. Keep in mind, however, that funds come in a variety of risk and return profiles. For example, a fund that invests in stocks of “hot” start-up companies may pose more risk (and possibly provide a higher long-term return) than a fund that invests mostly in bonds, which offer more moderate risk and a moderate return.

Choosing a fund

Before deciding whether to invest in a particular mutual fund, consider your investment objectives, risk tolerance and time horizon. Do as much research as you can, and use financial publications and websites to learn about specific funds. Many mutual fund company websites, including TIAA-CREF’s, include information that helps you sort through their mutual funds using various criteria.

Review the prospectus of any fund you’re seriously considering buying. The prospectus, which is a legal document, will offer many important details about the fund, including its investment objectives and technique and past performance. Find out about any commissions and other costs you may incur as an investor. Also, look up the fund’s expense ratio, which is calculated by dividing the fund’s annual expenses by its average net assets. All else being equal, the higher the expense ratio, the lower your return. To get a prospectus, contact the mutual fund company directly or download one at the company’s website.

Getting help from an advisor

There are a multitude of mutual funds and other investments to choose from and if you don’t feel knowledgeable enough to choose investments confidently, consider hiring a professional financial or investment advisor for guidance. An advisor can help you create the right mix of investments based on your personal goals, your time horizon for achieving those goals, and your tolerance for risk.

TIAA-CREF Individual & Institutional Services, LLC, and Teachers Personal Investors Services, Inc., members FINRA, distribute securities products.

You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 877 518-9161 or log on to www.tiaa-cref.org/prospectuses for a prospectus that contains this and other information. Please read the prospectus carefully before investing.

Diversification is a technique to help reduce risk. There is no absolute guarantee that diversification will protect against a loss of income.

© 2013 and prior years, Teachers Insurance and Annuity Association - College Retirement Equities Fund (TIAA-CREF), New York, NY 10017