What Are Mutual Funds

What Are Mutual Funds
Photo by Nazir Amin – CC BY-SA 2.0

For more than a century, the securities markets in the United States and other countries around the globe have been a haven or investors of all kinds. Individuals with varying degrees of expertise and financial influence have made fortunes or invested for the future using financial instruments such as stocks, bonds, and other securities. One of the most popular investments over the past 80 years has been mutual funds. These financial vehicles allow investors to diversify their holdings, get professional money management, and ensure their cash is secure among other benefits. For the few financial geniuses out there, this is common knowledge. The average investor is wondering exactly what are mutual funds?

What are mutual funds?

The fast answer to this question is that a mutual fund is a collective investment that is professionally managed. Money from different investors is combined to purchase securities such as stocks, bonds, short term money market instruments, and/or commodities. Other types of securities could also be included in a fund or they could be combined. In the U.S., mutual funds must be registered with the SEC or Securities and Exchange Commission. A mutual fund is typically overseen and managed by a board of trustees if it is organized as a trust and by a board of directors if it is organized as a corporation. Investors buy securities from within the fund as opposed to third parties such as the New York Stock Exchange (NYSE).

How do they work?

Investors of a fund purchase shares from the fund itself instead of on a securities exchange. They may also purchase shares from a broker of the fund. Buying a share of a mutual fund is not the same as buying a share of stock from any specific company. The value of a share from a mutual fund is equal to the funds per share net asset value or NAV. Fees imposed by the fund for services rendered may also be included in the price. Every individual share of a mutual fund is proportionate to the overall value of all the investments in the fund. The fund may be made up of stocks, bonds, commodities or a combination of these. Dividends, capital gains and/or interest are the primary income that can be gleaned from a mutual fund. Investors can also sell their shares back to the fund or a broker of the fund.

Why mutual funds?

Now that the question, what are mutual funds has been answered, you must decide if they are the right investment for you. Just like any other type of investment, benefits and drawbacks exist for mutual funds. One of the main benefits of a mutual fund is the ability for an individual to diversify their money over many different investments. There are generally varying types of the same securities that make up a fund such as stock in different companies or varying types of investments all together. If one type of security from within the fund should fail to perform well, the financial impact will not be as great as if all the money in the fund were invested in that one security. This assumes of course that other investments in the portfolio are doing well. Not putting all of your eggs in one basket is a staple for success in the securities markets. Another major benefit of a fund is the professional management that comes along with it. As mentioned before, funds are overseen by a board that hires a fund manager and makes decisions that are in the best interest of the fund investors. These professionals must comply with federal law governing mutual funds and generally have a lot of experience in securities investment management. Drawbacks to a mutual fund are reduced control over the type of investments that make up the fund and higher fees for managing and purchasing investments.

Mutual funds are a great investment for novice market players who are unsure of which securities to start investing in. They provide more security against loss than do other securities by themselves by diversifying money across a spectrum of investments. They are also one of few financial instruments that are professionally managed without input from investors. Some of the downsides however are that mutual funds generally have a greater number of and higher fees than when purchasing securities alone. Investors also have little to no say in what type of investments make up any particular fund. Now that you have the answer to what are mutual funds, you can better control your investment future.

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