A mutual fund company pools money together from a group of investors and invests that money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings of the mutual fund are known as a portfolio. Each share of the mutual fund is the investor's ownership stake in the holdings and the income those holdings generate.
The majority of mutual funds are open-end funds, which allows an investor to buy as many shares as they like as well as repurchase them. While there are others, the mutual fund is the most common pooled investment vehicle.
Some of the more distinguishing characteristics of mutual funds include the following:
- Investors purchase mutual fund shares from the fund itself (or through a broker for the fund) as opposed to other investors who purchase on a secondary market, such as the New York Stock Exchange or NASDAQ Stock Market.
- The price that investors pay for mutual fund shares is the fund's per share net asset value (NAV) plus any shareholder fees that the fund imposes at the time of purchase.
- Mutual fund shares are "redeemable," which allows investors to sell their shares back to the fund (or to a broker acting for the fund).
- Mutual funds often create and sell new shares to accommodate new investors on continual basis. This means if the fund only has 10,000 shares it will add more to accommodate new investors.
- Each mutual fund tends to have a specific investment objective and it endeavors to meet that criteria throughout the life of the fund.
Mutual Funds Are Affordable
Mutual funds tend to be well received because they are often very affordable. In many instances, you can open an account for as little as $1,000. You are also able to make small monthly contributions, in some cases as little as $50.
Mutual Funds Are Diversified
Most savvy investors prefer a diversified range of investments. By design, the mutual funds are already diversified. When you join a fund, you may own a combination of various stocks and bonds in a variety of sectors. Diversification helps to protect you against losses. For example, if stock A decreases by two percent and stock B increases by three percent, your net return would be one percent. This is the power of diversification.
Mutual Funds Are Liquid
Most mutual fund shares can be quickly sold back to the fund without penalty. This means you have access to your money when you need it most. When you sell back to the fund, you will receive the current share value at the time of sale. This means that if the selling price when you purchased your shares in the mutual fund were $48.50 and when you sold it back the share price was $55.25, you earned $6.75 per share sold back.
Before investing in any fund it is a good idea to get a copy of its prospectus, which is the official document that details the funds specific objectives, fees and past performance. While mutual funds are managed by professional fund managers, there are still risks. You should also consult a certified professional before investing to ensure you have a thorough understanding.