A mutual fund is a company that pools investors' money to make multiple types of investments, known as the portfolio. Stocks, bonds, and money market funds are all examples of the types of investments that may make up a mutual fund.
The mutual fund is managed by a professional investment manager who buys and sells securities for the most effective growth of the fund. As a mutual fund investor, you become a "shareholder" of the mutual fund company. When there are profits you will earn dividends. When there are losses, your shares will decrease in value.
Mutual funds are, by definition, diversified, meaning they are made up a lot of different investments. That tends to lower your risk (avoiding the old "all of your eggs in one basket" problem).
Because someone else manages them, you don't have to worry about diversifying individual investments yourself or doing your own record keeping. That makes it easier to just buy them and forget about them. That's not always the best strategy, however -- your money is in someone else's hands, after all.
Since the fund manager's compensation is based on how well the fund performs, you can be assured they will work diligently to make sure the fund performs well. Managing their fund is their full-time job!
Mutual funds can be open-ended or closed-ended. But many people consider all mutual funds to be open-ended, while putting closed-ended funds in another category.
"Open-ended" means that shares are issued in the fund (or sold back to the fund) whenever anyone wants them. With closed-ended funds, only a certain number of shares can be issued for a particular fund, and they can only be sold back to the fund when the fund itself terminates. (You can sell closed-ended funds to other investors on the secondary market, though.)
Load refers to the sales charges added to a mutual fund when you purchase it. The load charge goes to the fund salesperson as a commission and payment for their research services. Load charges can be up to 8.5 percent of the selling price and can be figured in as a front-end load (meaning you pay it when you buy the mutual fund) or a back-end load (meaning you pay when you sell the mutual fund).
Many mutual funds are no-load funds. Yes, that means there is no sales fee charged and the fund is direct-marketed so you can buy it without the help of a salesperson. With the wealth of information on the Internet today, it is certainly easier to make smart choices yourself to save money.
In addition to no-load funds, there are also funds that charge up to 3.5 percent as a sales fee. These are called low-load funds and can still be a good deal.
Mutual funds fall into three categories:
- Equity funds are made up of investments of only common stock. These can be riskier (and earn more money) than other types.
- Fixed-income funds are made up of government and corporate securities that provide a fixed return and are usually low risk.
- Balanced funds combine both stocks and bonds in the investment pool and offer a moderate to low risk. While low risk may sound good, it is also accompanied by lower rates of return-meaning you risk less, but your investment won't earn as much. You have to decide how much risk you're willing to take on before you invest your money.
If you have invested in a college savings fund or a 401k account, chances are good that already own a few mutual funds. Mutual funds are great for long-term investments like these. You can also buy mutual funds directly from a mutual fund company.
Most of these offer no-load funds (or sometimes low-load funds). You can find lists of mutual fund companies on the Internet and purchase shares by simply filling out an application and mailing a check. Once you are a shareholder, you will receive statements telling you how the fund is doing as well as how much your own investment is growing. You can also set up monthly bank transfers to automatically buy more shares every month.
Remember to do your research and select a mutual fund that fits the level of risk you are willing to take with your hard-earned cash. Then just sit back and hope for the best!
For more information on investing and financial planning, check out the links below.