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If you know anything about investing you’ve heard the term, mutual fund but do you know how they work? Don’t be embarrassed if you don’t. A ton of financial professionals don’t either. Keep reading and you’ll learn everything you need to know.

The Nuts and Bolts of a Mutual Fund

A Mutual Fund Is a Company

A mutual fund isn’t like a stock or a bond. It’s not so much a single investment product. It’s a company offering a service. That should change your perspective because a company has to offer a product or service and make money to pay for all of the costs that come with running a company—plus make a profit.

The company has to pay employees, keep the lights on, pay rent, and host the big company Christmas party. Just like a plumber, a grocery store, or a car dealership, a mutual fund company is offering you a service for a fee.

How a Mutual Fund Works

Most people don’t have the knowledge or experience to put together a complicated investment portfolio on their own. And most don’t have enough money to diversify their investments appropriately. At least that’s what people believe.

Mutual fund companies collect your money, combine it with other people’s money, and invest in some way. Mutual funds are set up with goals in mind. Some invest in stocks, bonds, or currencies.

Others stay with American companies while others go international. Some automatically change based on a target retirement date. If you’re planning to retire in 2035, you can put money in a target date fund that automatically sets you up with a portfolio that fits that goal.

You could put together a mutual fund of your own. Find a few rich friends, hire a super expensive attorney, and set up your “company” and start investing.

On the other hand, if you have a larger balance, you can create a diversified portfolio of your own at a fraction of the cost. Our platform can help you with that.

The Problems With Mutual Funds

First, they’re expensive. Guess who pays the lighting bill, the company employees’ salaries, and yes, for the Christmas party? The investors in the fund…you! That’s where the expense ratio comes in.

The expense ratio is the percentage you’re paying in fees. The higher the percentage, the less money you’re making. The average expense ratio is about 0.71%. That might not seem like a lot but small differences can multiply to far more than $100,000 over decades.

The other problem is that many mutual funds don’t do a very good job at what they’re trying to do. For funds that have managers trying to beat the market, they underperform more than half of the time. In other words, you paying extra money for a substandard result.

Read more: Mutual Funds Underperform in 2015

In theory, you could start a brokerage account, spend about $7 to purchase an exchange traded fund that mirrors the overall market, and be done with your investing. There is still a tiny amount of fees but barely any.

Or, you could use our platform, find a few stocks that our system identifies as up and comers, and try to beat the market on your own. No need to pay somebody else.

Bottom Line

Hopefully you understand how mutual funds work now. Your retirement money in the form of a 401(k) might have to stay in mutual funds but stick with low cost index funds. If you have control of your money, you have many other options. Check out our platform. The first month is on us.

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