Mutual Funds Explained

Introduction

If your parents have a retirement account, there is a good chance it holds mutual funds. Mutual funds have been around for about 100 years, and millions of people use them to invest. They make it easy to own a mix of many stocks and bonds without having to pick each one yourself. Here is how they work.

What Is a Mutual Fund?

A mutual fund pools money from many investors and uses it to buy a collection of investments, like stocks, bonds, or both. Each investor owns shares of the fund, and the value of those shares rises or falls with the fund's investments. Mutual funds are run by professional managers who decide what to buy and sell. This gives everyday investors access to a diversified portfolio with just one purchase.

Active vs. Index Funds

Some mutual funds are actively managed, meaning managers try to beat the market by choosing specific investments. These funds usually have higher fees. Others are index funds, which simply track a market index like the S&P 500. Index mutual funds tend to have low fees and, over long periods, often perform as well as or better than many actively managed funds.

Mutual Funds vs. ETFs

Mutual funds and ETFs are similar, but they trade differently. Mutual funds are priced once a day after the market closes, while ETFs trade throughout the day like stocks. Some mutual funds require a minimum investment, sometimes $1,000 or more, while you can buy many ETFs for the price of one share or less. ETFs are also often slightly more tax-efficient.

Things to Watch For

Before investing in a mutual fund, check its expense ratio, since high fees can eat into your returns over time. Some funds also charge sales fees, called loads, when you buy or sell. Look at what the fund invests in and how it has performed over many years, not just recently. Choosing low-cost, diversified funds is a smart strategy for most beginners.

Conclusion

Mutual funds let investors pool their money to own a diversified mix of investments managed by professionals. They come in active and index varieties, each with different costs. While ETFs have grown in popularity, mutual funds remain a major part of many retirement plans. Understanding them is a key step in becoming a confident investor!