What is a Mutual Fund?
A mutual fund is an investment instrument where hundreds or thousands of people pool their money to create a portfolio of securities, which includes stocks, bonds, real estate, and other securities. Each investor in a mutual fund owns a percentage of the fund.
Mutual funds enable investors to easily and cheaply own a diversified portfolio of securities. This allows investors to own a diversified portfolio for much less than it would cost them to buy the individual securities.
Most mutual funds require a small investment of a few hundred dollars to a few thousands dollars. Additionally, because mutual funds are diversified with hundreds or thousands of securities they tend to not fluctuate wildly when compared to owning a small amount of individual stocks, thus making them less risky.
Mutual funds are typically run by Mutual Fund Managers who determine what security to purchase and when to buy and sell these securities. The investor pays the Mutual Fund Managers via fund fees to make these day-to-day decisions.
There are hundreds of mutual funds categories to choose from. Some categories are as follows:
- Growth funds – invest in stocks of growing companies.
- Aggressive growth funds – invest in stocks of fast growing companies.
- Sector funds – invest in stocks of companies in a specific sector like technology or healthcare.
- Index funds – invest in stocks of every stock in a particular index, such as the S&P 500.
- Bond funds – invest in shares of government bonds, high-yield bonds (A.K.A. junk bonds), or municipal bonds.
- Value funds – invest in stocks that are cheap based on earnings to the price of the stock.
- Large-cap value funds – invest in stocks of large companies whose share prices are selling at discounted prices.
- Small cap value – invest in stocks of small companies (usually with market capitalization of less than $1 billion) that are ignored or unknown by investors.
- Growth-and-income, equity-income, and balanced funds – invest in a combination of dividend-paying stocks and income-producing securities, such as bonds or convertible securities, which are bonds or special types of stocks that pay interest but can also be converted into the company’s regular shares.
Things to consider when buying mutual funds are:
- Risk – Riskier funds may swing more in value depending on market conditions.
- Expenses – Mutual funds charge a percentage of total assets, which will cost you money.
- Taxes – Mutual funds that own dividend-paying stocks will issue dividends to the owners who have to pay taxes on these dividends. Even if the fund declines in value, the owner is still liable to pay taxes on the dividends.
- Performance – Past performance is no indication of future performance, however, looking at a funds past long-term performance gives a good indication of which funds may do well in the long-term future.
- Consider owning Index funds – Index funds mimic market benchmarks, such as the S&P 500 and are considered “passive” funds over “active” (or managed) funds because they have lower expenses and are more tax efficient. Most active funds underperform the S&P 500 index.
Mutual funds can be purchased and researched online at a variety of online brokerage houses, such as E-Trade, Fidelity, Schwab, Scottrade, and Ameritrade.
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