Mutual Funds: Frequently Asked Questions
A mutual fund pools money from many investors and uses it to buy a mix of stocks, bonds or other securities, managed by a professional or designed to follow an index. These answers cover the basics.
Why do people use mutual funds?
Funds make it easy to own a diversified portfolio with a small amount of money, and they handle the research and trading. That simplicity is attractive, especially for retirement accounts and automatic monthly investing.
What is the difference between an index fund and an actively managed fund?
An index fund aims to match a market benchmark and usually charges lower fees. An actively managed fund tries to beat the market, which costs more and does not always succeed. Over long periods, costs are an important factor in results.
What fees should I look for?
The expense ratio is the annual cost, taken from the fund's assets. Some funds also charge sales loads when you buy or sell, or ongoing distribution fees. The prospectus lists all costs, and you should compare them across similar funds.
How are mutual funds taxed?
In a regular taxable account, you may owe tax on dividends and capital gains the fund distributes each year, even if you reinvest them. You also owe tax on any gain when you sell your shares. Funds that trade often tend to produce more taxable distributions. Inside an IRA or a workplace plan, these distributions are not taxed until you withdraw money from the account.
Why does the timing of a purchase matter?
If you buy shortly before a fund pays a distribution, you may receive a taxable payout that simply returns part of your purchase price. Ask about the distribution schedule before making a large purchase late in the year.
How do I keep good records?
Track your purchase dates, amounts and reinvested distributions, because they determine your cost basis when you sell. Your fund company or broker may report basis, but you should keep your own records, especially if you transfer accounts.
What about exchange-traded funds?
ETFs hold similar baskets of securities but trade like stocks throughout the day. They can be tax-efficient and low-cost, though trading costs and the price you pay can differ from the underlying value.
Questions about how a fund will affect your tax return? Ask us.
This article is general information, not tax, legal or investment advice for your specific situation.