What are Mutual Funds?

Many conservative-minded investors don't want to take high risks when they invest their money. Instead of diving into the deep-end of the investment pool alone, which can be a scary plunge, they prefer to increase their comfort levels by surrounding themselves with other investors. Their money is pooled together to make a collective, diversified investment in mutual funds.

What are Mutual Funds?
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What Are Mutual Funds?

Mutual funds are investment vehicles operated by a professional money manager. Mutual fund companies, registered by the U.S. Securities and Exchange Commission (SEC) and managed by an SEC-registered adviser, combine the funds of multiple investors into joint investments. Each investor has a proportionate ownership of the combined funds through shares, which are bundled into a portfolio. Investors cannot purchase mutual-fund shares from the secondary market, such as a stock exchange. They must purchase shares directly from a mutual fund or through a mutual-fund broker. When an investor wants to sell her shares, she can sell them back to the fund or to the fund's broker.

Mutual Funds Pros

Even investors without a lot of money can typically invest in mutual funds. Some brokers have no minimum investment, which makes it possible even for a novice investor to dabble in mutual funds. Although there are risks associated with any investment, mutual funds are comparatively lower-risk than other types of investments, such as stocks and bonds, because of how mutual-fund investments are diversified. Instead of purchasing individual shares of stock to invest in a single company, the pooled resources of mutual-funds investors are invested over a diverse spectrum of companies or industries. This diversification allows investors to avoid the pitfalls of putting all their investment eggs in one basket. And if an investor wishes to redeem her mutual-fund shares, she can do that on any business day and receive her money within a week. The SEC notes that mutual-fund companies must send payment to their investors within seven days after they redeem their shares.

Mutual Funds Cons

Perhaps the biggest drawback to investing in mutual funds is that there is never a guarantee with any investment you make – all investments carry a measure of risk. When you invest in mutual funds, you're also looking at fees and expenses in addition to the amount of your investment. Fees may include management fees and annual fees, and other expenses may include sales charges and operating expenses. Even if your mutual fund yields a negative return on your investment, you still have to pay the fund's fees. And you won't be able to control which investments your mutual-fund company or fund broker makes. Once your funds are pooled with other investors in a joint portfolio, the fund broker determines how to invest the combined resources.

Mutual Funds Types

The SEC lists four main types of mutual funds: stock funds, bond funds, money-market funds and target-date funds. Stock funds are subdivided into numerous categories, including income funds, which make periodic dividend payments to supplement your income, and growth funds, which offer a higher-than-average potential return even though they do not pay on a regular basis like income funds. Bond funds vary widely in type as well as risk, simply because their goal is to produce high returns, which often carries a proportionately high risk. Money-market funds are typically low-risk investments because they invest only in short-term, high-quality investments. Target-date funds, also called lifecycle funds, are structured primarily around a specific target – an investor's retirement date. Target-date mutual funds offer a diverse mix of investments, such as stocks and bonds, which shift over time, depending on a particular fund's strategy.

Mutual Funds Examples

According to Kiplinger's 2018 report of mutual-fund rankings, Standard & Poor's 500-stock index paid a whopping 22 percent return for its stock mutual-fund investors in 2017. U.S. News & World Report ranks the USAA Intermediate Term Bond Fund and the Payden Corporate Bond Fund as examples of high-performing corporate bond mutual funds. Money-market mutual funds include investments in U.S. Treasury funds and <st1:country-region w:st="on"><st1:place w:st="on">U.S. government funds. JPMorgan Smart Retirement Income Fund and Vanguard Target Retirement Income are two types of target-date mutual funds.