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What Is a Mutual Fund?

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A mutual fund company pools money from individual investors and invests it, charging each investor a fee for the convenience of having someone else manage their investments. Investing in a mutual fund is an alternative to hand-selecting individual stocks and bonds and buying them independently. Sounds great, right? Not all mutual funds are created equal, though.

A financial advisor could help you put an investment plan together for your goals and needs. Let’s break down everything you need to know about mutual funds. 

Understanding the Basics of Mutual Funds

Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. Managed by professional fund managers, these funds allow individuals to access a broad range of investments without needing to buy each asset individually. This structure makes mutual funds an accessible option for both beginner and experienced investors looking to grow their wealth over time.

When you invest in a mutual fund, you’re essentially buying shares of the fund itself, not the underlying assets directly. The value of your investment rises or falls based on the performance of the fund’s holdings. Fund managers make decisions about which securities to buy or sell, aiming to achieve the fund’s stated investment objectives. This professional management can be especially beneficial for those who prefer a hands-off approach to investing.

There are several types of mutual funds, each designed to meet different investment goals and risk tolerances. Equity funds primarily invest in stocks and are suited for those seeking growth, while bond funds focus on fixed-income securities for more stable returns. Balanced funds combine stocks and bonds to offer a mix of growth and income and money market funds invest in short-term debt instruments for maximum liquidity and minimal risk.

One of the main advantages of mutual funds is diversification, which helps reduce risk by spreading investments across a variety of assets. Additionally, mutual funds offer liquidity, allowing investors to buy or sell shares on any business day at the fund’s net asset value. Professional management and the ability to start with relatively small amounts of money make mutual funds an attractive choice for many individuals.

Investing in Mutual Funds

What Is a Mutual Fund?

Many people encounter mutual funds when they get their first “big kid job” and start contributing to a 401(k) plan. Employees with 401(k)s generally get to choose between several mutual funds that will take pre-tax contributions and help them grow. As we mentioned, the investor doesn’t choose the holdings within a mutual fund. Instead, he or she chooses a) the fund company and b) the fund.

Choosing the mutual fund that’s right for your investments isn’t a decision to be taken lightly. A mutual fund might hold just stocks, just bonds or a mix of both (this is called a balanced fund). A mutual fund could hold domestic stocks and bonds or international ones. It could be a specialized fund that only invests in a certain sector, such as real estate or health care. It could be a Target Date Fund that holds a mix of stocks and bonds that rebalances according to how close the owner is to retirement. Or, it could be a money market fund, with returns that hover just above the returns on a regular savings account.

One type of mutual fund is important enough to be considered a separate financial product altogether. That’s the index fund, which tracks the performance of the overall market without trying to beat it. Index funds are the passive alternative to actively managed mutual funds that employ experts who try to beat the market. Index funds generally charge lower fees than their actively managed counterparts.

Mutual Fund Companies

What Is a Mutual Fund?

The biggest mutual fund companies are household names. Think Fidelity, Vanguard and Charles Schwab, among others. If you’re buying a mutual fund for your 401(k), you’ll be limited to what your employer offers. In some cases, employers offer funds from only one company. If you’re in that boat, your choices are constrained.

If you’re choosing between multiple mutual funds, it’s a good idea to compare expense ratios. The expense ratio, expressed as a percentage, tells you the percentage of a fund’s assets that the company keeps to cover operational and administrative expenses. The lower the expense ratio, the more of your money gets to grow and compound. In other words, the mutual fund to buy is the one that offers low fees.

No-Load Mutual Funds

A load fund is a mutual fund that charges a sales fee or commission. By contrast, a no-load mutual fund is a fund that doesn’t charge you a sales commission. A load might be expressed as a cash amount to be paid up-front when buying shares (a front-end load) or in several years when selling shares (a back-end load). Some back-end loans phase out if you hold the fund for long enough.

A mutual fund load could also be a level load, spread out over time. A no-load fund could still have high fees, so always check the expense ratio. There isn’t a correlation between higher loads and better returns, so if you can find one, it can be a good idea to go with a fund that has low/no loads and low fees.

Bottom Line

Mutual funds can be great options for folks who don’t want to take the DIY approach to investing. If you put your hard-earned money into a mutual fund, it’s important to make sure you understand how that fund works and what it’s charging you in fees. It’s not unheard of for people to put all their 401(k) investments into money market funds, only to realize decades later that their money has hardly grown, or has lost money due to high fees. If you’re not satisfied with the mutual fund choices available to you through your company’s 401(k), you can always bring up the issue with the company management. It’s your money, and you want to make the most of it.

Tips for Investing

  • However, you might consider working with a traditional financial advisor if you have a more complex financial situation or just prefer talking face-to-face. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you don’t have a lot to invest, you might want to consider a robo-advisor. Entirely online robo-advisors offer lower fees and account minimums than traditional financial advisors.

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