Imagine this: With one simple purchase, you can invest in hundreds of different securities, hire a professional manager, and keep your investment costs low. That represents the power and importance of mutual funds. Mutual funds pool money from individuals and organizations to invest in stocks, bonds, and other assets in different industry sectors and regions of the world. You can buy whole or fractional fund units directly from fund companies or through your broker. The price of each mutual fund unit reflects the market prices of the fund holdings, adjusted for management fees and expenses.
You can choose from hundreds of mutual funds offered by dozens of mutual fund companies. This wide selection gives you the flexibility to pick mutual funds that suit your financial objectives and risk tolerance. For example, equity and growth funds are suitable for aggressive investors who can tolerate periods of extreme market volatility. Balanced funds could be suitable for a more moderate investor looking for both capital gains and income, while bond funds would suit conservative investors who want preservation of capital and regular income.
Mutual funds are a cost-effective way to diversify your portfolio across different asset categories and industry sectors. Instead of buying and monitoring potentially dozens of stocks, you could buy a few mutual funds to achieve broad diversification at a fraction of the cost. For example, equity funds offer an indirect way to invest in dozens of companies in different industry sectors, while balanced funds offer exposure to both stocks and bonds. Further diversification is possible within each asset category. For example, you could buy mutual funds that specialize in certain industries within equities, such as technology and energy. Similarly, international funds and emerging market funds are convenient ways to diversify geographically.
Professional money management expertise at a reasonable cost is another important attribute of mutual funds. Fund managers typically have postgraduate finance degrees, and several years of stock analysis and investment management experience. Mutual fund companies use a combination of in-house research staff and the services of external research firms to determine the composition of fund portfolios. Fund managers may use information technology and sophisticated trading strategies to rebalance portfolios and hedge against market volatility.
Mutual funds have leveled the playing field by bringing the financial markets closer to small investors. For about the price of an average stock, you can participate in the capital gains and dividend distributions of potentially dozens of companies. You do not have to spend a sizable amount of your savings to invest in each one of these companies separately. Mutual fund companies are able to spread research, commissions, and related expenses over a larger asset base, which reduces the cost for individual fund investors. You can reduce the costs even further by holding index mutual funds, which track major market and industry indexes. These funds have low management fees and expenses because they do not have the research and trading costs of actively managed funds.
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