What Is a Mutual Fund?
A mutual fund is a company that invests in a portfolio of securities.
People who buy shares of a mutual fund are its owners or shareholders.
Their investments provide the money for a mutual fund to buy securities
such as stocks and bonds. A mutual fund can make money from its
securities in two ways: a security can pay dividends or interest to the
fund, or a security can rise in value. A fund can also lose money and
drop in value.
Different Funds, Different Features
There are three basic types of mutual funds-stock (also called
equity), bond, and money market. Stock mutual funds invest primarily in
shares of stock issued by U.S. or foreign companies. Bond mutual funds
invest primarily in bonds. Money market mutual funds invest mainly in
short-term securities issued by the U.S. government and its agencies,
U.S. corporations, and state and local governments. While all investments
are subject to certain risks, stocks have a greater degree of price
fluctuation risk than bonds. Therefore, from a risk/reward perspective,
stocks are considered to have more risk (and greater potential reward)
than bonds. Money market funds seek to preserve the value of an
investment at $1.00 per share, although it is possible to lose money by
investing in them.
Why Invest in a Mutual Fund?
Mutual funds make saving and investing accessible and affordable. The
advantages of mutual funds include professional management,
diversification, variety, liquidity, affordability, convenience, and ease
of recordkeeping-as well as strict government regulation and full
disclosure.
Professional Management Even under the best of market
conditions, it takes an astute, experienced investor to choose
investments correctly, and a further commitment of time to continually
monitor those investments.
With mutual funds, experienced professionals manage a portfolio of
securities for you full-time, and decide which securities to buy and sell
based on extensive research. A fund is usually managed by an individual
or a team choosing investments that best match the fund's objectives. As
economic conditions change, the managers often adjust the mix of the
fund's investments seeking to meet the fund's objectives.
Diversification Successful investors know that diversifying
their investments can help reduce the adverse impact of a single
investment. Most mutual funds introduce diversification to your
investment portfolio automatically by holding a wide variety of
securities. Moreover, since you pool your assets with those of other
investors, a mutual fund allows you to obtain a more diversified
portfolio than you would probably be able to comfortably manage on your
own-and typically for much less cost.
In short, mutual funds allow you the opportunity to invest in many
markets and sectors. That's the key benefit of diversification.
Variety Within the broad categories of stock, bond, and money
market funds, you can choose among a variety of investment approaches.
Today, there are about 8,200 mutual funds available in the U.S., with
goals and styles to fit most objectives and circumstances.
Costs Mutual funds usually hold dozens or even hundreds of
securities like stocks and bonds. For a no-load fund, meaning there is no
sales charge associated with buying shares, the primary way you pay for
this service is indirectly through fees and expenses that are based on
the fund's total assets. These fees and expenses are deducted from the
fund. Because the fund industry consists of hundreds of competing firms
and thousands of funds, the actual level of fees can vary. But for most
investors, mutual funds provide professional management and
diversification for less cost than making such investments independently.
Liquidity Is the ability to readily access your money in an
investment. Mutual fund shares are liquid investments that can be sold on
any business day. Mutual funds are required by law to buy, or redeem,
shares each business day. The price per share at which you can redeem
shares is known as the fund's net asset value (NAV). NAV is the current
market value of all the fund's assets, minus liabilities, divided by the
total number of outstanding shares. Keep in mind that bond and equity
funds will fluctuate in value, and at redemption, may be worth more or
less than the original amount invested.
Convenience You can purchase or sell fund shares directly from
a fund or oftentimes through a broker, financial planner, bank or
insurance agent, by mail, over the telephone, and increasingly by
personal computer. You can also arrange for automatic reinvestment or
periodic distribution of the dividends and capital gains paid by the
fund. Funds may offer a wide variety of other services, including monthly
or quarterly account statements, tax information, and 24-hour phone and
computer access to fund and account information.
Protecting Investors Not only are mutual funds subject to
exacting internal standards, they are also highly regulated by the
federal government through the U.S. Securities and Exchange Commission
(SEC). As part of this government regulation, funds must meet certain
operating standards, observe strict antifraud rules, and disclose
specific information to current and potential investors. These laws are
designed to protect investors from fraud and abuse. But these laws
obviously cannot help you pick the fund that is right for you or prevent
a fund from losing money. You can still lose money by investing in a
mutual fund. A mutual fund is not guaranteed or insured by the Federal
Deposit Insurance Corporation (FDIC) or Securities Investor Protection
Corp (SIPC).
For more information about securities, the fund industry and how funds
are regulated please refer to the following websites:
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