A mutual fund is a collective form of investment that pools cash to buy and manage a portfolio of stocks, bonds or other assets.
Broadly speaking, mutual funds exist to outsource the work of managing securities on behalf of unrelated individual investors.
Mutual fund managers are responsible for buying and selling the investments in the fund in line with an investment objective and specific risk factors.
The objective is detailed in the mutual fund prospectus, a document which also details the expected cost of running the fund and information on how much volatility to expect from the chosen investments.
A major attraction of investing through a mutual fund is the cost and convenience compared to buying and managing stocks or bonds on your own.
In addition, a focus of many “actively managed” mutual funds is to seek performance in excess of a benchmark. That is, they seek to beat the market return through timely buying and selling of investments rather than accept a return similar to the market.
Mutual funds pool investor money into a common pot to achieve broad diversification and professional management at a relatively low cost. For minimums as low as $100, an investor can purchase shares of mutual funds that own thousands of underlying investments and participate in broad diversification otherwise impossible to achieve.
Accordingly, mutual funds are tremendously popular with American investors. There are thousands of mutual funds in the market holding trillions of dollars in investments; nearly half of U.S. households owns one.
Mutual funds can have broad or narrow objectives. They invest in stocks, bonds, cash and other investments that meet the objectives of the fund. Funds may be constrained to investments in specific markets (such as the S&P 500 Index of stocks), sectors (real estate), country securities (bonds) or they may be unconstrained and flexible in their choices of investments.
While mutual funds are pooled investments, the most common type of fund is technically an “open-end investment company.”
That means fund shares are bought from and sold to the company based on the daily “net asset value” of the underlying securities, known as the fund’s NAV. Essentially, that’s the net cash value of the investments in the fund if you were to sell them all in a single day, divided by the number of shares in the fund.
Mutual funds have many advantages, including daily liquidity, ease of transacting, diversification into many underlying securities with low minimums and professional management. Over the last few decades mutual funds have declined in cost and lowered their minimums to invest, increasing their importance to the average investor.
Mutual fund regulation is another positive for investors. Funds outline their ownership, objectives, history, fees, risks and other material information in their prospectus, which is provided to new investors and filed with the U.S. Securities and Exchange Commission.
Fund investment holdings are disclosed on a quarterly basis, and all mutual funds have independent directors that monitor the potential for conflicts between investors and the mutual fund company.
Compared to some of the other ways one could invest, owning a mutual fund can present disadvantages. For instance, mutual funds do not pay taxes on their investment gains; rather, they pass the tax consequences on to their investors.
This pass-through of taxable gains on underlying securities can occur even if the fund declines in value. Despite stringent regulation, too, some actively managed mutual fund companies have been linked to investment scandals.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.