What is a mutual fund?
Mutual funds are managed portfolios of various types of securities. These funds combine investors’ capital to invest in stocks, bonds, money market investments or similar investments. Money managers, who attempt to produce capital gains and income for investors, oversee the portfolios.
Mutual funds are structured according to their prospectus. The prospectus specifies the fund’s objectives, investment strategies, risks, performance, fees and management. Funds differ according to risk and reward profiles.
One of the primary advantages of mutual funds is they allow individual investors to pool their money to create a diversified portfolio, even with a small amount of money.
However, mutual funds also come with fees and administrative costs. Loaded funds include fees that can be assessed on the front end or the back end. Front-end fees are charged at the time of the purchase, while back-end fees are charged when the investor sells the shares.
No-load funds don’t carry any front-end, back-end or sales commissions. However, these funds can still charge a fee of up to 0.25 percent of its annual assets. The fees are included in the fund’s expense ratio.
The three major types of funds are income, bond and equity funds. Income funds are designed to provide investors income and are made up of debt instruments, including government debt and high-quality corporate debt. While investors’ principal may grow, the goal of income funds is to produce regular income for investors, rather than to increase capital.
Bond funds are made up of debt securities, but the funds vary dramatically as there are many types of bonds available. Government security bond funds offer lower risk, whereas high-yield junk bonds are riskier.
Equity funds invest mainly in stocks and focus on long-term capital growth. Most equity funds design their portfolios to reflect certain types of companies. For example, large-cap stock funds mainly invest in companies that are valued at more than $5 billion.
Mutual fund example
Rosalyn graduates from college and lands her first job. As a part of her employer’s sponsored retirement plan, she arranges for 5 percent of her monthly income to be automatically invested in no-load funds. She’s chosen these funds because they have few if any costs associated with them. Even though Rosalyn is just starting out, she’s able to create a diversified portfolio.
Interested in maximizing your investments? Learn how to choose mutual funds like a pro.