Get a quick lesson on what a mutual fund is and how it works.
- A mutual fund is a pool of money from several shareholders and is managed by an investment professional.
- Some of the benefits of investing in mutual funds are professional investment management and diversification.
- Be sure to read the mutual fund’s prospectus to understand its fees and expenses and other important information about the fund.
A mutual fund is a pool of money from several shareholders and is managed by an investment professional. The investment professional invests in securities complying with the stated objective of the fund (i.e. growth, value, income, etc.). A mutual fund is valued daily and reports a price known as a net asset value (NAV) per share. In its simplest form, a NAV is the total value of all the securities held in a fund divided by the total number of shares owned by its shareholders. As the price of the NAV increases or decreases, the shareholder’s value will increase or decrease. Mutual funds can only be purchased once a day after the close of the market unlike individual securities that can be traded throughout the day.
Benefits of a mutual fund
Some of the benefits of investing in mutual funds are professional investment management and diversification. As stated above, the securities held in a mutual fund are determined by the investment professional and are based on the objective of the fund. The investment professional has many resources readily available and an extensive knowledge of the financial markets which, when combined with the financial understanding of individual companies and securities, helps to determine the securities to buy and sell. This removes the burden of an individual investor having to select, monitor, and sell individual securities and places it with an experienced investment professional who does this work all day.
What are the different types of mutual funds?
An investor can seek to select from three general types of mutual funds: stock, bond, or money market. However, the marketplace has evolved and there are funds that focus on non-traditional asset classes like REITs, private equity, and even hedge funds. By selecting different types of mutual funds, an investor can diversify risk. Since some asset classes react differently to market conditions, holding investments in different types of mutual funds should help to lower the risk of the investor’s overall portfolio. In addition, the mutual fund structure diversifies risk for an investor, by providing the investment professional sufficient funds to purchase and sell several different securities. Thus, a shareholder’s risk should be lower since gains on some securities can be offset by losses on other securities. Also, an investor’s cost to buy a mutual fund is usually less than having to diversify by buying individual stocks and bonds.
Mutual fund fees and expenses
Since an investment professional is hired to manage the mutual fund, the fees for their service need to be paid. The investment fees and other expenses related to operating a mutual fund are deducted daily from the total value of the fund prior to the NAV calculation. To review the fees and expenses, an investor should read the mutual fund’s prospectus. In addition to the fees and expenses of the mutual fund, the prospectus will also provide additional information such as: investment objective, investment professional managing the fund, historical investment performance, how to purchase and redeem shares, along with other information relevant to making an informed decision.
Other information regarding the mutual fund can be obtained through the fund’s semi-annual and annual reports, as well as the fund’s Statement of Additional Information. If you don’t have time to read through these materials, there are some good websites that summarize this information and allow you to compare funds with similar investment objectives. The most popular site is Morningstar.com but most investment firms now offer similar information and tools. For more information about mutual funds and other investment topics, visit www.finra.org/investors.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, investment, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought. All investments involve risks, including possible loss of principal. There is no assurance that any investment strategy will be successful. Diversification does not ensure a profit or guarantee against a loss. Third-party trademarks and brands are the property of their respective owners.