By Amy Buttell
Mutual funds are pools of money. Money from many different individual investors can be pooled with money from, say, the retirement fund of a global corporation.
This money is managed full time by professionals who are paid for their financial management expertise.
Mutual funds invest in a portfolio of stocks (equities), bonds, or money market instruments. You, the shareholder, own a proportionate part of the fund in much the same way you would be an owner of a company in which you buy stock.
If a stock fund invests in the stocks of 50 companies, you own a part of those 50 companies. You share ownership in the fund with other individuals and sometimes with institutional investors.
Investing in mutual funds has similarities to investing in stocks, but there is one difference: Most funds are "open-ended." An open-ended fund is one in which there is no fixed amount of shares outstanding.
Investors can buy shares in an open-ended mutual fund at any time, and in unlimited quantities, as long as the fund is open to new investments. This is in contrast to stocks and closed-end mutual funds, which issue a certain number of shares.
the advantages of mutual fund investing
- Diversification: When you invest in a mutual fund, you get instant diversification of your holdings by owning a part of each company that your fund invests in.
- Rules regulate mutual fund transactions, advertising, and communications with investors.Professional management: Mutual fund managers have more time, expertise, and resources to manage investments than most individual investors do. However, fund managers have widely varying levels of experience and different track records, which you should examine carefully.
- Convenience: Mutual funds provide a great deal of convenience for busy investors. Not only is it fairly easy to purchase fund shares, but mutual fund companies also offer automatic transfers and reinvestments of dividends and capital gains. You can also transfer your money from one fund to another.
- Selection: There is a mutual fund available for virtually any type of market sector that you might be interested in.
- Liquidity: Mutual funds offer an important combination of appreciation potential plus liquidity. Shares can be redeemed at the end of each day, based on the fund's net asset value (NAV).
- Concise information: Based on mandates from the Securities and Exchange Commission (SEC), fund companies are obligated to provide a simple, easy-to-understand prospectus and investor reports. A prospectus spells out a fund's goals, strategies, fees, and expenses. The shareholder report describes the fund's most recent performance.
- Protection: While mutual fund investors are not insured against investment loss, rules do exist that regulate mutual fund transactions, advertising, and communications with investors.
the disadvantages of mutual fund investing
- No guarantee: As previously noted, mutual fund investors are not protected by any guarantees against losses in their fund investments. Stock mutual funds invest in stocks, and the stock market rises and falls. Individual holdings within a fund, and individual funds, fluctuate in value.
- Fund objectives: There are several investment information companies that categorize funds by their investment objective. Make sure that your fund manager invests according to the stated objective. Some funds drift away from their stated objective, and your money could be sitting idle as cash or being invested in different types of securities than the fund's objective states.
- There is a mutual fund available for any market sector you might be interested in.Diversification: Yes, diversification is both an advantage and disadvantage in mutual fund investing. Although investing in a large number of companies through a mutual fund can help insulate you from taking a huge loss in the stock market, it also prevents you from realizing a large gain that a smaller portfolio might realize.
- Fees: Mutual fund fees vary widely from fund to fund, and, in many cases, exceed the cost of employing a full-cost broker. Be aware of front-end sales charges, back-end sales charges, and ongoing operating expenses that cut into your returns.
- Capital gains: Unless your mutual fund investment is in a tax-sheltered account, you will be obligated to pay capital gains tax on the distributions you receive from mutual fund companies. By law, a fund's capital gains are passed on to shareholders, who must pay tax on them.
how a typical mutual fund is structured
A mutual fund is structured as a corporation or business trust. Mutual fund shareholders receive regular statements and reports.
The fund itself has no employees. An independent board of directors oversees a fund.
An investment adviser or management company is hired to manage the fund's holdings and make all buy and sell decisions.
Mutual fund shareholders do not participate in portfolio management decisions, although they may receive notice of meetings and may be asked to vote on issues related to the fund owner.
This article was originally published by BetterInvesting. Since 1951, BetterInvesting has helped more than five million people become better, more informed investors. BetterInvesting helps its members build wealth through educational webinars, Web-based mutual fund and stock tools, in-person learning events, publications, an active online community, and software. For more information, visit the website or call 877-275-6242.
Neither CUNA nor the author of this article is a registered investment adviser. Readers should seek independent professional advice before making investment decisions.