Have you ever wondered how mutual funds work — or how they could benefit you? Explore the basics of mutual funds to determine if they could help with your investment strategy.
Learning more could help you understand if mutual funds could be an excellent choice for your portfolio needs.
What Are Mutual Funds?
In a nutshell, mutual funds are a type of investment made up of a pool of funds from many investors. A mutual fund includes assets — or securities, such as stocks and bonds — and may sometimes include short-term money market instruments or other securities or assets, or even some combination of these investments. A professional mutual fund manager makes decisions on behalf of investors as to which assets to buy and sell.
You may also have heard the term "index fund" when researching investment strategies. An index fund automatically tracks an entire index of the stock market while a mutual fund's assets are carefully selected by the fund manager.
Advantages of Mutual Funds
So, why might you consider investing in a mutual fund? One significant advantage is that you could have access to funds you might not be able to afford otherwise because you're pooling your money with fellow investors. And because you're investing in a collection of many stocks and bonds, you aren't putting all your eggs in one basket, so to speak.
Mutual funds are also typically purchased to fund long-term goals such as retirement. They may be included as part of a retirement account or an individual retirement account (IRA), and they can also be held outside of a retirement portfolio. Note that mutual-fund investing involves fees and expenses, and many mutual funds require a load or sales charge when purchased or sold. There may also be an annual fee. It's important to be aware of all the fees involved with mutual funds before you invest in them.
Types of Mutual Funds
While there are many different kinds of mutual funds, some of the more common types include:
- Growth funds: Growth mutual funds are diversified portfolios of stocks focused on the increase in capital or in the value of the investments themselves. These mutual funds primarily include newer, high-growth companies that usually reinvest their earnings into making the company more profitable. Note that with growth mutual funds, you may not receive a dividend payout.
- Small-/Mid-/Large-cap funds: "Cap" or "capitalization" indicates the size of the companies a mutual fund invests in. A company's market cap is determined by the number of shares outstanding multiplied by the current market price of one share. For example, a company with half a million shares outstanding selling at $100 a share would have a market cap of $50 million. Small-cap funds typically include companies with a market cap of less than $1 billion, mid-cap funds typically have a market cap of $1 to $8 billion and large-cap funds have a market cap of $8 billion or more.
- Socially responsible funds: Those interested in connecting profit with purpose may look toward investing in socially responsible funds. These funds include companies that are committed to making an environmental or social impact. The companies invested in typically must meet environmental, social and corporate governance (ESG) criteria.
- Sector funds: Sector funds include companies that are part of a specific industry or sector, such as biotechnology, precious metals or utilities. These funds are concentrated in a narrow part of the market and thus typically offer less diversification than other types of mutual funds.
- Bond funds: Bond funds are mutual funds that include a pool of bonds or debt securities. These funds may include a broad mix of bonds from corporations, government agencies or the U.S. government itself. Some bonds focus on a narrower part of the market, such as high-yield corporate bonds. Some bond funds may also pay out dividends.
Mutual funds are meant to offer a more efficient way to invest than investing in individual companies, and they might be a good option for consumers who are starting out and want to learn about different types of investments. They could also be a solid option for those in search of funds that are in alignment with their long-term money goals.
So, how do mutual funds work? By understanding the answer to that essential question, you'll be more informed when considering your approach to growing your money over both the long- and short-term. Please note that all investing involves risk, including the possible loss of some or all of the original investment.
Mutual funds are sold by prospectus. Investors should consider a fund's investment objectives, risks, charges and expenses carefully before investing. To obtain a free prospectus, please contact your financial professional or go to the fund's website. An investor should read the prospectus carefully before investing.