What Are Mutual Funds?

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Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.
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What Are Mutual Funds?

Mutual funds are a type of investment that allows you to pool your money with other investors and then have a professional manager invest the money for you.

A mutual fund investment manager will choose stocks, bonds, and other securities that they believe will perform well, and the mutual fund will then be bought and sold based on those choices.

There are many different types of mutual funds, each with its own investment strategy.

Some mutual funds focus on stocks, while others focus on bonds or other types of investments. There is no one right type of mutual fund for everyone; it depends on your individual goals and risk tolerance.

Mutual funds can be a good way to diversify your investment portfolio. By investing in a mutual fund, you can get exposure to a wide range of investments without having to buy and sell each one individually.

Mutual funds come with some risks. The value of your investment can go up or down, depending on how the fund performs. You may also pay higher fees and expenses to invest in a mutual fund, which can eat into your investment returns.

Before investing in a mutual fund, be sure to research the fund’s investment strategy, performance history, and fees and expenses. This will help you determine whether the fund is a good fit for your investment goals.

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Benefits of mutual funds

Mutual funds offer the following benefits:

Diversification

By investing in a mutual fund, you can get exposure to a wide range of investments without having to buy and sell each one individually.

The average mutual fund contains over 100 securities. This can help you diversify your investment portfolio and reduce your overall risk.

Convenience and Liquidity

Mutual funds are easy to buy and sell, and they offer a convenient way to invest your money.

They can be bought and sold on stock exchanges, so they are relatively liquid and most brokers have them.

Low Minimum Investment

Mutual funds often have a low minimum investment, so you can start investing with a small amount of money.

Save costs

Building your own portfolio can cost commissions and other trading costs (e.g., the bid/ask spread).

When you invest in a mutual fund, the fund manager does the work of buying and selling investments, so you can save on costs.

Variety

There are many different types of mutual funds, from growth and income, fixed income, money market funds, and target date funds (e.g., based on one’s retirement age).

Professional Management

When you invest in a mutual fund, you hire a professional manager to make investment decisions on your behalf.

This can save you time and effort compared to managing your own investments.

Subject to industry regulation

Mutual funds are subject to industry regulation by the Securities and Exchange Commission (SEC). This provides some protection for mutual fund investors.

 

Drawbacks of mutual funds

Mutual funds have the following drawbacks:

Market risk

The value of your investment in a mutual fund will go up or down based on the performance of the underlying investments.

No FDIC insurance coverage

Mutual funds are not FDIC-insured (FDIC coverage is relevant to US investors and other countries have similar deposit insurance), so you could lose money if the fund goes bankrupt.

Moreover, if the fund loses money, this is not covered by insurance.

High cash presence in mutual fund portfolios

Mutual funds require a significant amount of their portfolios to be held in cash in order to satisfy share redemptions each day.

This can reduce returns, as over time cash is the lowest-performing basic investment.

High fees compared to ETFs

Mutual fund fees can be higher than ETFs. Also, mutual funds often have hidden fees, such as 12b-1 fees, which can eat into your investment returns.

Given mutual funds are active investments, the operating costs are passed on to the investor.

These are often called expense ratios.

The average mutual fund expense ratio for mutual funds are around 0.5 to 1 percent. They rarely exceed 2 percent.

By comparison, for passive index funds, the typical ratio is about 0.2 percent.

Examples of mutual fund fees

12b-1 Fees: These are marketing and distribution expenses charged by the mutual fund.

They are often paid out of the mutual fund’s assets, which reduces the investment’s potential return.

Manager fees: The mutual fund manager is paid a fee for their services. This fee is typically a percentage of the assets under management (e.g., 1 percent).

Loads: A load is a sales charge that is paid when you buy or sell shares of a mutual fund.

There are two types of loads: front-end and back-end.

A front-end load is paid when you purchase shares and is typically a percentage of the purchase price (e.g., 5 percent).

A back-end load is paid when you sell shares and is also commonly a percentage of the sale price (e.g., 3 percent).

Transaction fees: These are fees charged when you buy or sell shares of a mutual fund.

They are typically a few dollars per transaction, depending on what your brokerage charges and the bid-ask spread combined with the volume of shares purchased.

Risk Considerations

All investments come with some degree of risk, and mutual funds are no different. The level of risk will depend on the type of mutual fund you choose.

For example, mutual funds that invest in stocks tend to be riskier than those that invest in bonds.

Before investing in a mutual fund, make sure to do your research and understand the risks involved.

No voting rights

Stocks provide shareholders voting rights while mutual funds do not.

This is because mutual funds are not direct ownership in companies in the truest sense, but rather a collection of investments.

 

Mutual funds – Common questions

How do mutual funds work?

A mutual fund is an investment vehicle that is made up of a pool of money from many different investors.

The money in the mutual fund is then used to purchase a variety of different investments, such as stocks, bonds, and other securities.

Each mutual fund has its own investment objective and strategy.

Some mutual funds are designed to track a specific market index, while others are actively managed by professional money managers.

Mutual funds are a popular choice for investors because they provide diversification and professional management.

Are mutual funds a good investment?

Mutual funds can be a good investment for those who are primarily looking for two things:

  • they want to avoid concentrating their money in any one thing
  • they’re looking for something professionally managed

However, mutual funds also come with some risks, such as market risk and fees.

Before investing in a mutual fund, make sure to do your research and understand the risks involved.

What companies offer mutual funds?

Vanguard mutual funds

Some of the best mutual funds are from Vanguard.

They offer a variety of mutual funds with low expense ratios and have a good reputation for performance.

Vanguard ETFs are often some of the cheapest in the industry for those who don’t need active management.

Fidelity mutual funds

Another reputable company offering mutual funds is Fidelity.

They also have a wide selection of mutual funds with competitive expense ratios.

Schwab mutual funds

Charles Schwab is another well-known financial services company that offers mutual fund investing. Like Vanguard and Fidelity, they offer a variety of mutual fund options with low fees.

What are the 4 types of mutual funds?

Most mutual funds fall into one of four main categories:

  • money market funds
  • bond funds
  • stock funds, and
  • target date funds

Money market mutual funds

These mutual funds invest in short-term debt instruments, such as government bonds and commercial paper.

They are considered to be very low risk and provide stability for your portfolio.

Bond mutual funds

Bond mutual funds invest in a variety of debt securities, such as corporate bonds, government bonds, and municipal bonds.

They tend to be less volatile than stock mutual funds but more volatile than money market mutual funds.

Stock mutual funds

Stock mutual funds invest in a basket of stocks representing different sectors of the economy.

They can be broadly diversified or focused on a specific sector, such as healthcare or technology.

Target date mutual funds

Target date mutual funds are designed for people who are saving for retirement. They invest in a mix of stocks and bonds that is appropriate for the target date (e.g., 2030).

The asset allocation becomes more conservative as the target date approaches.

What are mutual fund fees and expenses?

Mutual fund fees are the charges you pay to invest in a mutual fund and the operating costs associated with running one.

They can include management fees, 12b-1 fees, loads, and transaction fees.

What is a mutual fund’s expense ratio?

The expense ratio is the annual fee that mutual funds charge to cover their operating expenses. It is expressed as a percentage of the fund’s assets.

For example, if a mutual fund has an expense ratio of 0.50 percent or 50bps, that means it will charge $50 for every $10,000 invested.

What is a mutual fund’s turnover rate?

The turnover rate is the percentage of a mutual fund’s holdings that are bought or sold in a given year.

A high turnover rate can indicate that the fund is being actively managed and incurring higher transaction costs.

What is a mutual fund’s load?

A mutual fund load is a sales charge that is paid when you purchase or sell shares of the fund. Loads can be front-end, back-end, or level.

A front-end load is paid when you purchase shares of the fund, while a back-end load is paid when you sell shares of the fund.

A level load is a type of mutual fund that charges a constant fee, regardless of whether you buy or sell shares.

What is a mutual fund’s 12b-1 fee?

The 12b-1 fee is an annual marketing and distribution fee that mutual funds charge.

It is expressed as a percentage of the fund’s assets and is used to cover the costs of marketing and selling the fund.

What are mutual fund sales charges?

Mutual fund sales charges are fees that you pay when you purchase or sell shares of a mutual fund.

These charges can include front-end loads, back-end loads, and level loads.

What is a mutual fund’s redemption fee?

A mutual fund’s redemption fee is a charge that you pay when you sell shares of the fund.

This fee is typically charged by mutual funds that have a front-end load.

What is a mutual fund’s minimum investment?

The minimum investment is the smallest amount of money that you can invest in a mutual fund.

This amount can vary depending on the mutual fund company and the type of mutual fund.

What is an index mutual fund?

An index mutual fund is a type of mutual fund that tracks a particular market index, such as the S&P 500.

Index mutual funds are often passively managed and have low expense ratios.

What is an actively managed mutual fund?

An actively managed mutual fund is a type of mutual fund that is actively managed by a team of professional money managers.

These funds typically have higher expense ratios than index mutual funds.

What is a mutual fund’s investment objective?

The investment objective is the goal that a mutual fund seeks to achieve for its investors.

It can be anything from capital appreciation to income generation.

What are mutual fund shares?

Mutual fund shares are units of ownership in a mutual fund.

You can buy or sell shares of a mutual fund depending on the price of the underlying assets in the fund.

What is a mutual fund’s NAV?

The NAV, or net asset value, is the price of a mutual fund share.

It is calculated by taking the total value of the assets in the fund and subtracting the liabilities.

What is a mutual fund’s ticker symbol?

The ticker symbol is a short code that is used to identify a particular mutual fund.

Ticker symbols are typically four or five letters long (such as VTSAX or VWEHX) and can be found on financial websites and news outlets.

What is a mutual fund’s portfolio?

The portfolio is a collection of investments that a mutual fund holds.

The composition of the portfolio will depend on the investment objective of the fund.

What is a mutual fund’s asset class?

The asset class is the type of investment that a mutual fund holds.

Common asset classes include stocks, bonds, and cash.

How do you make money in mutual funds?

There are two ways to make money in mutual funds: through capital gains and through dividends.

Capital gains occur when the value of the assets in the fund increase.

When you sell your mutual fund shares, you will receive the difference between the purchase price and the sale price.

Dividends are payments that mutual fund companies make to shareholders out of the earnings of the fund.

These payments can be made on a monthly, quarterly, or annual basis.

What is mutual fund risk?

Mutual fund risk is the chance that you will lose money by investing in a mutual fund.

All investments carry some degree of risk, but mutual funds can be subject to higher levels of risk depending on their investment objectives and strategies.

What is the safest mutual fund?

Bond and money market mutual funds are considered safest in the sense that their value will move around less than those that contain riskier investments like equities.

The three types of bond funds considered safest are:

  • government bond funds
  • municipal bond funds, and
  • short-term corporate bond funds

Can I get monthly income from mutual funds?

Yes, you can get monthly income from mutual funds.

The best way to obtain monthly income from a mutual fund is to opt for a Systematic Withdrawal Plan (SWP) when you own a mutual fund.

Through a SWP, you can withdraw a fixed amount of money on a monthly or quarterly basis from the investment you’ve made in any mutual fund.

What is the difference between mutual funds and stocks?

Both mutual funds and stocks are securities that represent an ownership stake in a company.

The key difference lies in how mutual funds and stocks are managed.

Mutual funds are professionally managed by investment managers, while stocks may be bought and sold by individual investors.

Another key difference is that mutual funds pool money from many different investors to purchase a basket of stocks or other securities, while each stock represents an ownership stake in just one company.

Finally, mutual funds are typically more diversified than individual stocks.

This, in turn, reduces risk but also potential returns.

For example, it is not uncommon for an individual stock to rise or fall more than 5 or 10 percent in a day. But it is rare for a mutual fund to do this.

What is the difference between mutual funds and ETFs?

Exchange-traded funds (ETFs) are similar to mutual funds in that they both offer diversified portfolios and can be used to invest in a variety of asset classes.

However, there are several key differences between mutual funds and ETFs.

For one, mutual funds are priced once per day after the market closes, while ETFs are traded throughout the day on an exchange.

This means that mutual fund investors only know what their shares are worth at the end of each day, while ETF investors can see how their investment is performing throughout the day.

Another key difference is that mutual funds are actively managed by professional money managers, while ETFs are typically passively managed.

This means that mutual fund managers will make decisions about which stocks or other securities to buy and sell in order to achieve the fund’s investment objectives, while ETF managers simply seek to track a specific index.

Finally, mutual funds typically have higher fees than ETFs. This is because mutual funds are actively managed, which requires more manpower and thus results in higher costs.

ETFs, on the other hand, are passively managed and so have much lower operating expenses.

Also: ETNs vs. ETFs: What’s the Difference?

When did the first mutual funds come out?

On March 21, 1868, in London, the prospectus for the earliest known mutual fund was published. 

The Foreign and Colonial Government Trust offered shares to the public for £85.  

It invested in emerging market bonds from countries such as Argentina, Australia, Chile, Egypt, Peru, Turkey, and the US.

 

Conclusion

Mutual funds can be a good way to diversify your investment portfolio and get exposure to a wide range of investments.

However, mutual funds come with some risks, such as market risk and high fees.

Before investing in a mutual fund, be sure to research the fund’s investment strategy, performance history, and fees and expenses.

This will help you determine whether the fund is a good fit for your investment goals.

ETFs may be a better option for some investors, as they typically have lower fees and can be traded throughout the day.

However, ETFs may not offer the same level of diversification as mutual funds.

Ultimately, the best investment for you will depend on your specific financial goals and risk tolerance.