Learn About Mutual Funds Before You Invest

Newspaper turned to the Mutual Funds Section, with glasses, pen, and a cup of coffee
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Mutual funds are a popular investment option. Chances are you own mutual funds in your retirement plan or brokerage account. But how much do you really know about them?

Learn what you should know about mutual funds and how they can help with successful investing.

Key Takeaways

  • Mutual funds are an investment that allows a group of investors to pool their money and hire a portfolio manager.
  • All mutual funds charge fees to operate and manage the fund. Management fees pay the fund companies—or managers—to manage the funds.
  • There are many types and styles of mutual funds. There are stock funds, bond funds, sector funds, money market funds, and balanced funds.
  • The beauty of mutual funds is that you can invest a few thousand dollars in one fund and obtain instant access to a diversified portfolio.

What Are Mutual Funds?

Mutual funds are an investment that allows a group of investors to pool their money and hire a portfolio manager. With the fund's stated goal or focus in mind, the manager invests this money in stocks, bonds, or other securities.

The fund manager continues to buy and sell stocks and securities according to the style dictated by the fund’s prospectus.

Note

The prospectus is a document that provides information about the mutual fund; this includes its objectives and strategies.

How Much Do Mutual Funds Cost?

All mutual funds charge fees to operate and manage the fund. Management fees pay the fund companies, or managers, to manage the funds. Some funds also charge investors an upfront sales charge/load when they first purchase shares in the fund. Other funds charge a back-end load upon the sale of fund shares. This is also known as a contingent deferred sales charge. Some funds have no sales charge and are known as “no-load funds.”

Further, 12b-1 fees are imposed by some funds to cover marketing and distribution costs. There are also various share classes of funds that differ in fee structure according to class; these include Class A, Class B, and Class C.

How Are Mutual Funds Structured?

Technically, mutual funds are “open-end” funds. They are one of four basic types of an investment company. Closed-end funds, exchange-traded funds (ETFs), and unit investment trusts are three other types.

How Are Mutual Funds Regulated?

As investment companies, mutual funds are regulated under the Investment Company Act of 1940.

Regulation of mutual funds is extensive. This is even more true when compared to other pooled investment options like hedge funds. Mutual funds must comply with a strict set of rules monitored by the Securities and Exchange Commission (SEC).

The SEC monitors mutual fund compliance with the Act and adherence to other federal rules and regulations. Since their development, the regulation of mutual funds has provided investors with confidence in terms of the structure.

How Are Mutual Funds Diversified?

The beauty of mutual funds is that you can invest a few thousand dollars in one fund and obtain instant access to a diversified portfolio. Otherwise, to diversify your portfolio, you might have to buy individual securities. This exposes you to more risk. And it's not as simple, either.

Another reason to invest in mutual funds is their adherence to a basic principle of investing: Don’t put all your eggs in one basket. In other words, many different types of investments in one portfolio decrease your risk of loss from any one of those investments.

Here's an example. Let's say you put all of your money into the stock of one company. Then, it files for bankruptcy, You've just lost all of your money.

Now, let's say you invest in a mutual fund that owns many different stocks. In this case, it is more likely that you will eventually grow your money. At the very least, one company’s bankruptcy will not mean that you lose your entire investment.

How Are Mutual Funds Managed?

Many people don’t have the resources or time to buy individual stocks. Investing in individual securities, such as stocks, takes a lot of resources. And it also takes quite a bit of time.

In contrast, managers and analysts of mutual funds have dedicated their professional lives to researching and analyzing their holdings and potential holdings for their funds. They are well equipped to make investment decisions.

What Types of Mutual Funds Are There?

There are many types and styles of mutual funds. There are stock funds, bond funds, sector funds, money market funds, and balanced funds.

Mutual funds allow you to invest in the market, whether you believe in active portfolio management or you prefer to buy a segment of the market with no interference from a manager (passive funds and index funds). The availability of different fund types allows you to build a diversified portfolio at a low cost. And it can be easy, too.