What are mutual funds? That’s a great question to ask because if you’re wondering the answer, it means you’re interested in investing and growing your wealth.
To put it simply, a mutual fund is a pool of money that’s used to invest in stocks, bonds, and other securities. Investors provide the money that goes into the mutual fund, and a mutual fund manager decides where the money will be invested.
Inside each mutual fund are shares of numerous companies. So, one share of a mutual fund could include small percentages of Apple, Microsoft, and Warren Buffett’s company, Berkshire Hathaway. Many investors believe this is a more conservative way to invest because you spread out your risk.
To put it another way, if one company inside your mutual fun portfolio experiences poor performance in the market, the other companies can balance it out. For that reason, buying mutual funds is considered less risky than buying individual stocks.
The price of a mutual fund is known as the net asset value (NAV) per share, sometimes referred to as NAVPS. The NAV is determined by dividing the total value of the securities in the portfolio by the total number of outstanding shares.
Types of Mutual Funds
There are four main types of mutual funds: equity funds, fixed-income funds, balanced funds, and money market funds.
Equity Funds
An equity fund is a type of investment vehicle that invests in stocks, also known as equities. It’s a type of mutual fund that pools together money from many investors and uses that money to buy a diversified portfolio of stocks. The value of an equity fund is determined by the value of the stocks it holds.
Equity funds, also known as stock funds, may focus on a specific sector of the market, such as technology or healthcare, or they may be more broadly diversified, holding stocks from a variety of sectors.
Fixed-Income Funds
A fixed-income fund is a type of mutual fund that invests in fixed-income securities, such as bonds, debentures, and other debt instruments. Sometimes referred to as bond funds, these securities pay a fixed rate of interest to the investor, which can provide a stable source of income for investors.
Balanced Funds
A balanced fund is a type of mutual fund that invests in a mix of stocks and bonds, with the goal of providing both growth potential and income. The proportions of each asset class varying depending on the specific goals of the fund.
Money Market Funds
A money market fund is a type of mutual fund that invests in short-term, low-risk debt securities, such as certificates of deposit (CDs), commercial paper, and government securities. These investments are considered to be highly liquid, meaning that they can be easily bought and sold on the open market.
Among these categories are thousands of different mutual funds to choose from. Here is an example of one of them.
Please note: This is not a recommendation to purchase this particular fund. It’s just an example so you can see how they encompass numerous stocks.
The Schwab Total Stock Market Index Fund
This is an index fund. An index fund is a type of mutual fund where the fund managers try to track and mimic a certain index, like the S&P 500 or the Dow Jones Industrial Average. So, if the S&P 500 is up 2% on any given day, an index fund that tracks the S&P 500 should technically also be up 2% on the same day.
The Schwab Total Stock Market Index Fund does just what it sounds like. It tracks the total returns of the entire U.S. market.
The top 5 holdings in this fund are:
- APPL, Apple Inc makes up 3.72% of this fund.
- MSFT, Microsoft Corp, makes up 2.87% of this fund.
- AMZN, Amazon.com Inc, makes up 2.69% of this fund.
- FB, Facebook Inc A, makes up 1.40% of this fund.
- BRK/B, Berkshire Hathaway Inc B makes up 1.33% of this fund.
That means when you buy mutual fund shares, they’re actually made up of investments representing several companies. So, instead of buying individual shares of APPL or FB, which can be risky, you can buy mutual funds like this that already includes many of these companies.
What is a mutual fund account, and how does it work?
Here is a step-by-step guide for opening an account:
- Step 1: Decide how much money you have to invest in mutual funds. Some companies will let you start investing with as little as $100 whereas others might require minimums like $3,000.
- Step 2: Find a broker that offers mutual funds, preferably one that allows you to invest with the amount you’ve saved for this purpose. Fidelity, Vanguard, and Charles Schwab are just a few of the many well-known companies out there.
- Step 3: Double-check fees. Make sure you know how much of your money will go to mutual fund fees. Typically, actively managed funds have higher fees than passively managed ones. Do your research to decide which is best for you.
- Step 4: Open your account. Now that you know how much you want to invest, and you’ve decided on a company to invest with, open your account with them. Once your account is open, put in an order to buy mutual funds.
- Step 5: Check-in. You can check in and track your returns at any time, and you should, so you stay knowledgeable about your investment portfolio.
How do you make money from mutual funds?
Ideally, you make money from mutual funds through your investment returns. So, if you bought one share of your mutual fund for $50, but a year later it’s now worth $100, you’ve doubled your money. You can then sell that share and pocket the profit, keeping in mind you’ll likely have to pay taxes on that profit.
Can you lose money with mutual funds?
Yes, you can. The stock market can be unpredictable. On any given day, stocks can go up or down. If the market is down, your investments can go down too.
The good news is that mutual funds are made up of several stocks, bonds, or securities. That means that even if one investment in the mutual fund is having a bad day in the market, another could be having a great day. That’s why so many investors, both new and experienced investors, like mutual funds because it’s a way to invest conservatively.
What’s the difference between ETFs and mutual funds?
While you’re researching mutual funds, you might come across a term called an ETF or an exchange-traded fund. Exchange-traded funds are very similar to mutual funds in that they are a fund made up of numerous investments.
The difference is that you can trade ETFs like stocks, which means you will often pay a fee to buy and sell them. However, ETFs often have lower fees and expenses than mutual funds. Additionally, only a few ETFs are actively managed like mutual funds.
See also: What’s the Difference Between ETFs and Mutual Funds?
What are the benefits of mutual funds?
There are many benefits to investing in mutual funds.
- Diversification – As mentioned previously, investments inside mutual funds can represent several types of stocks, bonds, and securities.
- Liquidity – You can sell mutual funds easily.
- Professional management – Mutual funds typically have professional managers choosing where to invest your money.
Can you withdraw money from mutual funds without penalty?
If you’re invested in mutual funds inside a retirement account like an IRA or 401(k) you may be charged an early withdrawal penalty if you are under the age of 59 and a half. If you sell a mutual fund that’s not within a retirement account, you may not get a penalty, but you might have to pay capital gains taxes if you profited from your investments.
How much money do you need to start investing in mutual funds?
As mentioned previously, some companies will allow you to invest in mutual funds with as little as $100. The key is to take your time and do your research. Find out management fees before you choose a company to invest with. Furthermore, take a look at the historical returns of a particular fund you’re interested in to learn more about how it weathers market fluctuations before investing in it.
Final Thoughts
Mutual funds are an extremely popular and common way to invest. There are thousands of mutual funds available for investors, and many companies that offer them. Now that you have a basic understanding of what a mutual fund is, you can take begin researching to find one that’s best for you and your future goals.
