A mutual fund is an investment you’ll find in most people's portfolios. Consisting of a collection of different products, such as stocks, bonds and other investments, mutual funds offer customers a mix of investments in a single package. In return, shareholders own a percentage of the value of the fund, and hold equity in each of the securities in which the fund invests.
Mutual funds are popular not just because they provide investors with diverse investment options, but also because they come in so many different flavors. There’s a mutual fund out there for just about every type of investor.
A mutual fund is operated by a fund manager, who makes investment decisions based on the fund’s prospectus. This is a legal document filed with the Securities and Exchange Commission that explains the fund’s objectives, investment strategies, risks, performance, distribution policy, fees and expenses, and fund management. A potential investor can read the prospectus to determine if the fund suits his or her own investment needs.
When you consider the features and benefits of mutual funds, it’s not surprising they are so popular:
Diversification. Because individual mutual funds typically invest in many different securities, they allow you to much more broadly diversify your investment than if you were, for example, buying individual company stocks. Mutual funds also lessen exposure to risk. For example, if one company in the fund went bankrupt, the overall impact on your portfolio would be less than if you had invested everything in that one company.
(To achieve a truly diversified portfolio, however, you may need to invest in several different types of funds. For example, if you invest solely in an energy-related fund, a drop in fuel prices would ripple across all companies in the fund, exposing you to greater losses.)
Professional management. Many people don’t have the time, skill or financial resources to research and buy a balanced portfolio of individual stocks and bonds.
Affordability. Many mutual funds allow investors to join with only a small initial investment and to make small, periodic contributions thereafter. All mutual funds do charge fees, which vary from fund to fund, so be sure to read each fund’s prospectus carefully.
Liquidity. Most mutual funds allow shareholders to sell shares at any time, without penalty (unlike CDs, for example). Of course, there are fees associated with selling shares, so frequent trading can be costly.
Variety. Mutual funds run the gamut. You’ll find options that range from conservative to aggressive, based on your investment style. Or if there’s a particular sector or industry in which you want to invest, you’ll likely find mutual funds that match your interest.
Mutual funds do come with some risk. Like many investments with no guaranteed return, there’s always a chance that a mutual fund’s value will depreciate depending on market conditions. Plus, unlike banks, whose deposits are guaranteed by the FDIC in case of bankruptcy, mutual funds are not guaranteed by the U.S. government.. Still, mutual funds are an investment investors should consider for a diversified portfolio.