Think of a mutual fund as a collection of stocks or bonds with something in common
By investing in a mutual fund, you’re essentially pooling your money with other investors to access a broader range of stocks or bonds than most people could own by themselves.
Every mutual fund reflects a particular investment objective and style, such as growth or value, which affects the stocks, bonds, and/or other securities that it buys. Knowing this can help you to determine whether a fund would be a good fit for your overall portfolio.
Funds have some advantages over individual stocks or bonds, including:
- Diversification. For a minimum investment, you gain exposure across broad market segments at a fraction of the cost of owning representative individual securities on your own.
- Professional management. You don’t have to keep track of the individual securities that make up the fund. An expert fund manager takes care of that by buying and selling as needed to help the fund meet its objectives.
- Convenience/liquidity. You can buy and sell mutual funds daily during market hours by phone or online, so you can always access your money.
When you invest in a fund, you purchase shares along with many other investors. The cost of a fund share is called the net asset value (NAV). For example, if you invest $1,000 in a fund with an NAV of $50, you will own 20 shares.
Active and index
There are two main types of mutual funds: actively managed and index. With an actively managed fund, a fund manager attempts to exceed the average returns of the market. There is the risk that the fund manager’s selection may underperform, but there is also a chance to beat the market.
Index funds try to track the return of a benchmark index such as the S&P 500 Index by owning securities that make up the index or a representative sample. They won’t beat the market, but they shouldn’t substantially underperform it either. They usually have lower costs than actively managed funds and are generally more tax-efficient.
Active and index funds can complement each other in a well-diversified portfolio.