All investments carry some risk. A stock investment may be volatile. A safer investment may have lower risk but make you very little money. Mutual funds offer the following advantages over other types of investments:

-         Mutual funds offer diversity. Your money is invested in a selected pool of securities. Thus, the risk is spread out in the pool.

-         Mutual funds require less of an initial investment than some other investments. This makes them accessible to more people.

-         Mutual funds allow you to take advantage of an experienced manager’s knowledge. When you invest in a mutual fund, you are essentially paying for investment expertise. Handpicking investments is something you may not have the time or desire to do.

Mutual funds have many advantages; however, mutual funds do have their own set of pitfalls for the unaware investor.

Pitfall #1--         Not Completely Understanding the Risk in Mutual Funds

This pitfall is easily remedied. Investors considering a mutual fund should read the fund’s prospectus before investing. The prospectus covers this important information:

-         The fund’s investment goals

-        If the fund pays dividends

-       Past fund performance

-       The amount of risk in investing in this fund

Study the prospectus carefully and make your investment decision after you have considered this information. For information on how to read a prospectus, visit this informational site at Rutgers University.

Pitfall #2--         Not Understanding Mutual Funds Taxes

Taxes on mutual funds work differently than taxes for individual stocks. With a stock:

-       You pay annual taxes on dividends or interest.

-         You only pay capital gains taxes on the stock when you sell it if the stock made you money.

With a mutual fund:

-         You pay annual taxes on dividends.

-      You may have to pay annual taxes on the mutual fund’s capital gains if they have a profit during that year that is not offset by a loss.

Make sure you understand the tax implications of a mutual fund before investing. For more on mutual funds and taxes, visit Morningstar.

Pitfall #3--         Not Understanding Mutual Fund Fees

Mutual funds come with various fees:

-         An initial charge when you begin investing

-         A yearly fee for management

-         A transaction fee when you buy and sell shares

Make sure you understand these fees. Compare these fees when shopping for a mutual fund. Fees should not be your only criteria for selecting one fund over another. However, high fees will eat into your investments over time. The U.S. Securities and Exchange Commission (SEC) has information on mutual fund fees at www.sec.gov/answers/mffees.htm and www.sec.gov/investor/tools/mfcc/mfcc-int.htm.

Pitfall #4--         Confusing Bank Products with Mutual Funds

Some investment products from banks sound very similar to certain mutual fund products. The difference is that bank products typically are FDIC insured, and mutual funds are not.

-        A money market fund is a mutual fund. It has a prospectus, but it is not a bank product and may not be insured by the FDIC.

-         A money market deposit account is a deposit to a bank. It is FDIC insured subject to the FDIC limits.

Additional confusion is possible when banks sell mutual fund products. These products include:

-        Mutual funds

-         Money market funds

Although these products have the bank name associated with them, they are not bank deposits. Thus, the FDIC may not insure them.

Pitfall #5--         Assuming that a Mutual Fund’s Name Completely Represents its Investment Philosophy

Mutual funds may have names such as “Minnesota Stock Fund” or “High Growth Fund.” However, according to SEC law, mutual funds are only required to invest 80% of their holdings in investments that are represented in the fund’s name. Therefore, the “Minnesota Stock Fund” might have 20% of its holdings in investments other than stocks. On the other hand, the “High Growth Fund” may actually include very conservative holdings.

The prospectus will outline all of a fund’s holdings, so study it carefully before investing and determine whether the fund meets your investment objectives and philosophy. Also remember that a mutual fund’s past performance does not guarantee its future performance. Looking at the past returns in the prospectus, however, can give you a sense of the fund’s volatility in the past.

Additional Resources
-       U.S. Securities and Exchange Commission: http://www.sec.gov/investor/pubs/inwsmf.htm#pitfalls 
-       U.S. Securities and Exchange Commission: http://www.sec.gov/investor/tools.shtml 
-       CNNMoney.com Web site: http://money.cnn.com/pf/funds
-       Yahoo Finance Web site: http://finance.yahoo.com/funds
-    U.S. Securities and Exchange Commission: http://www.sec.gov/investor/pubs/beginmutual.htm