How to make money from a mutual fund?

There are multiple ways to earn money from a mutual fund:

If the mutual fund is investing in stocks, these stocks might rise in price. When you sell these stocks for a higher value, this is called capital gain. Keep in mind that you can't actually sell bonds or stocks when investing in a mutual fund. The mutual fund manager can decide to sell stocks that have increased in price and return the gains to their investors. Or buy new stocks with more growth potential. 

Stocks may also pay dividends. Dividends are an extra flow of money on top of capital gains. The fund manager may decide to reinvest all dividends to get more shares. There are many dividend focussed stocks.

The price a new investor has to pay to buy mutual fund shares may also increase over time. As the mutual fund finds more investors and grows their portfolio causing the mutual fund share price to increase. Meaning you can sell your mutual fund shares at a higher price.

All of the above can happen at the same time. In financial troubling times stocks mostly decrease in price and companies may decide to lower or stop paying dividends. While in an uprising market stock prices rise and companies have more money to spend meaning they can decide to pay more dividends. It’s very unlikely to see stock, fund and dividends rising in a troubling market. 

But also be aware of the pitfalls. Dividend stocks may look nice from the outside, they have more risk of losing capital gains. If fund managers have a strong focus on dividend payments then stock prices are less important. But that might backfire. For example:

Suddenly something happens in the market causing the stock price to fall to $30. Because they still pay a 3% dividend, the stock is still in the portfolio. But you had a severe capital loss (from $50 to $30). 

The biggest risk from mutual funds comes from high fees. High fees have a huge impact on your returns. We will dive into the numbers in a later chapter.

20.1 Mutual funds and taxes

Calculating taxes for a mutual fund can be a very complex task. Not only because there are so many variables, taxes also vary between countries. It’s impossible to list every tax rule you should know about. Fortunately the IRS has a publication about all the tax rules (in the U.S.) called publication 550.

The amount of taxes you have to pay is based on your current income, the amount of money you have in your savings account and the amount invested, the type of securities you invested in, your household (alone or with a partner) and many other variables. 

In some cases, it might be beneficial to hire someone to do your taxes. Although keep in mind that you also have to pay the person that does your taxes. Best would be to learn how to do it yourself. 

20.2 What to look for in a mutual fund

It’s almost impossible to compare each mutual fund. There are so many different portfolio’s out there, the possibilities are endless. The main difference between all funds are the fees you have to pay and the amount of risk depending on the securities the fund is buying or tracking.

Picking the mutual fund that fits your needs can be a daunting task. You actually have to do some homework before picking the right fund. You need to know a few things:

You have to be very confident to let someone else handle your money. It would not be wise to just pick a fund and go with the flow. There are many costs associated with buying shares from mutual funds. You also need to know who runs the fund. Did they manage funds before? What are the statistics from the last few years? What are their goals? Do they reinvest their own money? 

While past performance may give you some clues, sometimes it does not mean anything. Any new fund would have great results if they started in the last few years (2015-2021). Because the market only went up. Also, some smaller portfolio’s might hold a upcoming star that performed very well for the last few years. Meaning the biggest gains comes from just a single stock. Mutual funds that had the top performance this year may be one of the worst in the next year.

As mentioned in my investing guide for beginners, your age is an important factor when choosing your investment strategy. You need to know the risks. Funds with lower profits also have lower risks. Also, have a detailed look at your tax requirements. High gains might look good on paper, don’t forget you have to pay fees, taxes and inflation.

Since there are many mutual funds out there, you should also compare them. Probably the most important thing to look at are fees. High fees will cause a huge effect on your returns. You can have a great mutual fund managing a very well balanced portfolio but if you have to pay excessive amounts of fees it’s not worth it. Mutual funds are not insured and have zero guarantees.

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