What Are Mutual Funds?
We break down the basics of one of the most common investment vehicles for new investors.
Editor's note: This article originally ran on Oct. 12, 2020.
Mutual funds are one of the most common investments for new investors building portfolios and are often a staple in employer-sponsored retirement plans, such as 401(k)s. Mutual funds are financial vehicles made up of a pool of money collected from many investors to invest in a variety of securities, including stocks, bonds, money market instruments, and other assets. Because mutual funds diversify investments among a number of securities, they provide instant diversification and are therefore less risky than holding an individual security, such as single stock.
Many mutual funds require investors to make a minimum investment. These minimums differ based on whether someone is investing through a No Transaction Fee network, investing in an IRA, or signing up for an automatic investment plan, like a 401(k).
Is a mutual fund the right investment for you? Here is what you need to know.
Investors who do not have a lot of financial experience or a lot of time and interest to assemble and monitor a basket of stocks or bonds on their own find themselves at the same place, wondering where they should invest. Mutual funds are popular options for investors in this position because they are professionally managed. This means that one or more appointed individuals are supported by a research team to manage the fund. The fund managers do the individual security selection for you.
When investors choose a mutual fund, they do not directly own the underlying holdings that make up the fund. Rather, they are shareholders of the mutual fund, not each security or asset that makes up the fund.
For example, let's say you choose to invest in Vanguard Institutional Index (VINIX). Although you are an investor in this fund, you are not a shareholder of Apple (AAPL), and you cannot vote at Apple's annual meetings.
Because there are a variety securities that mutual funds can invest in, there are several different types of mutual funds. Some of the most common types are equity funds, fixed-income funds, index funds, and money market funds.
Like all investments, mutual funds come with a price tag. Shareholders pay ongoing fees and expenses for owning a mutual fund. There are a variety of costs, such as:
Is a mutual fund the right investment for you? Before answering that question, there are some things you need to consider first.
Why are you investing? Before buying shares in a mutual fund or any other investment, you need to establish why you are investing in the first place. If you are investing for retirement or if you are investing to buy a home, your investment needs and strategies for both are going to look very different. Start off by calculating how much time you have and how much risk you can afford. Use these resources to help determine your investing goals:
Although mutual funds are a popular choice, that doesn't mean they are the only choice. Consider all your investment options and explore the ins and outs of other investment vehicles:
Carole Hodorowicz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.