An Introduction to the Basics of Mutual Funds

What Every Investor Should Know About Mutual Funds

A man looks at his mutual funds investments on his tablet while at home at night

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If you're a new investor, you might be wary of buying stocks on your own. Mutual funds offer a simple way to build your portfolio, but you should know what they are before you invest in them.

Mutual funds offer a way for a group of people to pool their money so they can invest in a wider range of securities and have their money managed through the purchase of one fund share. When you buy a fund share, you're buying stocks, bonds, and other securities that are held within the fund.

A fund passes along its profits (and losses) to people who invest in it. If it does well, you'll do well. Still, these funds are not risk-free. Read on to learn more about how they work.

What Makes Mutual Funds a Good Place for Your Money

Mutual funds are one of the most chosen investments among investors and financial professionals alike, but why is buying into a fund a good idea? While some funds perform better than others, it's what they grant you access to that is perhaps the best thing about them. They can give you the chance to diversify your money across a wide range of investments that you might not be able to carry in your portfolio as individual securities.

Since mutual funds invest in a diverse range of investment options, one fund share represents a portion of ownership in each and every item in the fund. People like the fact that each share gains them the profits of those investments. Mutual funds have to pass along profits to people who invest in them, through mutual fund distributions, which come in a few forms.

In a mutual fund, the value of your shares goes up and down as the values of the stocks and bonds in the fund rise and fall. For most people, to have the same access to those options and profits on their own would cost a lot both in terms of the actual dollars invested and time.

Getting into a fund is often a way to gain access to professional money management without paying too much in fees and other costs. If you tried to invest in stocks and bonds and actively manage them the way a fund's leader does, it could become a full-time job. In order to make wise choices when you buy stocks and bonds on your own, at the very least you'd need to have the knowledge to do a lot of research on all of the types of businesses in general and also on all types of companies. That is work that most of us do not have the time or background to do. By buying shares of a fund, you're also paying for the money management and skills of the fund manager, whose job it is to invest the money in the fund based on its goals.

Mutual Fund Fees Cover Administrative Costs

Mutual funds can offer a simpler way to invest, but they're not free. There are certain fees you have to be aware of when getting into funds.

Investors in the fund are charged a portion of the amount of money they have in the fund to help cover all the costs of running it, including having a fund manager as well as what it costs to research, buy, and sell stocks.

People can benefit from their collective investments. Mutual fund fees are spread out over all of the investors. As a result, the costs to each person are still much less than they would have been if he or she had bought the stocks directly and paid a broker or advisor to manage them.

Though many fund options are indeed cost-effective, there are many types of mutual fund fees, from front-load fees to constant-load fees. In this regard, it is always best to be aware of the type of fee and what it is for before putting your money into a fund. 

Other Types of Mutual Funds: Index Funds

Today, not all funds are managed by a financial manager. Index funds use a computer program to buy all of the stocks in a defined index, such as the Russell 3000 or the S&P 500, without regard to how they are doing right at the moment. They don't have to do research or try to time the flow of the market to buy or sell at the "right" time. Index fund fees, then, can be much lower than the fees for managed funds. As a result, your return can be higher.

Make Wise Choices

When picking funds to invest in, do your research. Take time to look at each fund's fees and asset allocation to make sure you're choosing a fund that fits your money goals and risk tolerance. Also, look at how the fund has done so far. While past gains and losses don't decide future results, it only makes sense to look at how much a fund has gained or lost in the past to gauge how it may do down the road.

Article Sources

  1. U.S. Securities and Exchange Commission. "Mutual Fund Fees and Expenses."

  2. Investment Company Institute. "Investment Company Fact Book 60th Edition," Page 127.