A mutual fund is a type of investment that pools money from many investors and uses the funds to buy a portfolio of stocks, bonds and other assets. Individual investors buy shares of the mutual fund rather than shares of the assets the fund holds. Share price is based on the fund’s net asset value. Fund investors get a proportional share of any dividends, capital gains and other income generated from the fund’s holdings. Like any other investment, mutual funds have benefits and risks.
One important benefit of mutual funds is professional investment management. Funds employ professional money managers who research possible investments, select the most promising ones, monitor their performance and sell off the poor performers. Mutual fund money managers, known as investment advisers, must register with the federal Securities and Exchange Commission. For new investors who are uncertain about how to pick an investment, mutual funds offer a way to own a good portfolio right at the start.
Mutual funds spread your investment across a wide range of companies and industry sectors, minimizing your risk of loss if a company or sector fails. This makes mutual funds a relatively safe investment. Mutual funds can also be more affordable than individual stocks or bonds for investors with limited capital. Many funds have low investment requirements for initial purchases and subsequent purchases. Mutual funds also offer liquidity. On any business day, investors can sell their shares back to the fund for their current net asset value, less transaction fees.
One major risk you take by investing in mutual funds is lack of control. You are taking on faith the investment wisdom of the fund’s money managers. Fund investors typically aren’t told the exact makeup of the fund’s investment portfolio, and they have no say over which securities the fund’s managers buy or sell. Because mutual funds buy into many diverse sectors, their returns are vulnerable to broad-based market downturns. Fund investors also have no control over the timing of taxable capital gains distributions, so they could find themselves with unexpected tax bills.
Although mutual funds are sold by banks, they are not covered by federal bank insurance. Money put into a bank-sponsored mutual fund is considered an investment, not a deposit, so the Federal Deposit Insurance Corporation won’t cover your losses if the mutual fund collapses. Fund investors also must pay annual fees, transaction charges and carrying costs regardless of how well the fund does. These fees can significantly reduce the return on your fund investment.
It can be difficult to know what your mutual fund shares are worth. The prices of all stocks traded on the major exchanges are available hour by hour or even minute by minute from many sources. By contrast, only very large mutual funds are tracked day to day on financial websites or brokerages. Many smaller funds are not listed, so the only source of share value information may be the fund itself. Also, stock prices continually change, and shares can be bought or sold any time during the business day. But the net asset value of mutual fund shares is updated once, at the end of the business day, so you could miss out on share value increases that occur on the day you sell your shares.