What's a mutual fund?
A mutual fund, also referred to as an open-end fund, is an investment company that spreads its money across a diversified portfolio of securities -- including stocks, bonds, or money market instruments.
Shareholders who invest in a fund each own a representative portion of those investments, less any expenses charged by the fund.
Mutual fund investors make money either by receiving dividends and interest from their investments, or by the rise in value of the securities. Dividends, interest and profits from the sale of any securities (capital gains) are passed on to the shareholders in the form of distributions. And shareholders generally are allowed to sell (redeem) their shares at any time for the closing market price of the fund on that day.
Go to the MarketWatch Mutual Funds page for news, commentary and data on funds.
Why invest in mutual funds?
There are a variety of reasons why investors might choose mutual funds over other investments, such as individual stocks and bonds. The number one reason is diversity, which can both increase your potential returns and decrease your overall risk.
Mutual funds allow an investor to spread out his or her money across as few as a handful to as many as several thousand companies at one time.
Funds can be especially advantageous for small investors who would be forced to pay enormous transaction fees if they bought the securities individually, and for investors who either don't have the time to research their own investments or who don't trust their own investment expertise. (For more on asset allocation, see "Build Your Own Mutual Fund Portfolio" tool).
That said, mutual funds aren't necessarily low-cost investments. Many of them charge one-time "load fees" to new purchasers that can exceed 5 percent of the investment, and all mutual funds take on average take 1.3 percent of assets a year for operating expenses, expressed as the "expense ratio."
As a result, "index" funds (see below) have surged in popularity in recent years because, on average, they provide a much lower expense ratio than managed funds. Also an index fund's risk is limited to that of the benchmark index that it tracks, such as the Standard & Poor's 500.
Finally, the rapid emergence of 401(k) plans as the retirement vehicle of choice for millions of Americans means that mutual funds are here to stay.
Professional management can be both a benefit and a liability of actively managed mutual funds. Several studies show that, over time, the average, actively managed fund has underperformed the overall stock market. Still, by picking funds with good long-term track records, managers you trust and low expenses, investors can build a portfolio with the potential for steady, long-term returns that match their own investment goals and tolerance for risk.
Liquidity -- the ability to readily access your money -- is another benefit of mutual funds. Funds can be sold on any business day at that day's closing price – or at the following day’s close if the sell order is placed after the market closes.
The price per share at any given time is known as the net asset value, or NAV, which is the current market value of all the fund's assets, minus liabilities, divided by the total number of outstanding shares. As new investors buy into a fund, the number of outstanding shares goes up, as does the market value of assets, but the NAV remains the same.
Mutual fund educational links
- Online classes are a fun way to learn mutual fund basics
- Take The Vanguard Group's mutual fund quiz
- The American Association of Individual Investors' glossary of mutual fund terms
- The Investment Company Institute’s Web site for mutual fund facts and figures
