About half of all American households own mutual funds, and they are one of the most common holdings in retirement accounts. They are considered less risky than owning individual stocks and bonds because the assets are spread across a large and diverse number of holdings. Mutual funds do still bring risks, but investors can select less volatile funds if they want to minimize those risks.
Mutual Fund Basics
Mutual funds provide a simple way for most people to put their money into a wide range of investments. They are a chance to diversify your portfolio by spreading your assets across many different companies or financial instruments. You also take advantage of the services of a professional fund manager who does the leg work and research. Mutual fund families help you determine your potential risks by categorizing their funds into different risk categories, from low to high and in between.
Risk vs. Reward
You can buy mutual funds that have conservative holdings, such as money market accounts or Treasury bills, and they will bring low risks. On the other hand, you can choose mutual funds that invest in emerging markets, small companies, real estate or other potentially volatile investments. The conservative funds come with little risk, but they also don't offer much potential for big returns. High-risk investments may come with a big payoff, with double digit returns or better in a good year. They also offer the greatest risk, and in a bear market you could see your portfolio take a giant hit.
Bull and Bear Markets
All markets go through bull and bear cycles. In some years when stocks don't do well, the bond markets rise, and vice versa, so having money in both lowers your overall risk. Real estate markets also go through up and down cycles, and mutual funds allow you to take some risks in the hopes of eventually reaping rewards by investing in real estate without the hassle of actually buying a physical property and the added risks that go along with being a landlord or homeowner.
You've heard a million times not to put all your eggs in one basket. Mutual funds allow you to spread your investments into many different baskets. Except in extremely usual economic times, all types of investments don't go down at the same time, so you can minimize your risks by balancing your portfolio. Money for retirement or that you don't otherwise need for a long time can go into riskier stocks or real estate funds. Some of your money can go into bonds, which are less risky than stock but also offer less growth potential. There are mutual funds that hold cash and cash equivalents if you want to keep some of your money very safe.
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