A mutual fund is both an investment as well as a company. It allows you to pool your money with other investors which is then used to invest in a portfolio of different things like stocks, bonds, money market instruments, properties, etc.
Mutual funds are operated by money managers who decide how to invest the money in an attempt to produce growth or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match a particular investment strategy. In other words, the money managers pick investments that they believe will meet the stated goal of the fund.
When you buy into a mutual fund you are actually buying a portion of the portfolio’s value. The value of the mutual fund doesn’t fluctuate during the day like an individual stock, rather its value is settled at the end of the trading day.
The positives:
Mutual funds are an easy way for beginner investors to get started.
Mutual funds give you diversification allowing you to invest in many different things. The more diverse the fund the fewer risks you take on.
Mutual funds are managed by a professional that makes investment decisions based on the goals of the fund. Typically you don’t have to babysit your investment.
Mutual funds allow you to reinvest the interest, dividends, and capital gains into additional mutual fund shares.
The negatives:
Mutual funds may have high fees. Be aware of the expense ratio before buying.
Mutual fund prices are only calculated at the end of the day, compared to stock, which fluctuates throughout the day.
You can only sell your shares at the end of the day after the market closes. This limits your ability to react to the market swings, up or down.
You don’t have control over the portfolio, that lies with the fund manager.
Mutual funds can sell profitable investments to create capital gain, even if the fund has performed poorly, which means you could lose money on an investment, but still pay taxes on it.
Overall, a mutual fund creates an opportunity for new and experienced investors to diversify their investment dollars in one place, helping you as an investor control some investment risks. Today, mutual funds are used mostly in 401(k) type retirement plans. Very few investors still use mutual funds outside of retirement plans.
Next week I will explain Exchange Traded Funds, (ETF’s). Informal Survey: What is your favorite Mutual Fund? Post in the comments!
“Better to buy part of a company than the whole thing.” - Warren Buffet