Introduction to Mutual Funds

Mutual funds have been a popular investment choice for Americans since the 1980s. Many investors have been very successful with their mutual fund exposure through these years. The common notion about mutual fund investments is that they are a risk free and effortless way to make money in the stock market. While this is not always true, mutual funds do offer some unique benefits to investors.

Table of Contents
Chapter 1: Introduction to Mutual Funds
Chapter 2: Categories of Mutual Funds
Chapter 3: Understanding Mutual Fund Terminology
Chapter 4: Mutual Fund Costs
Chapter 5: Buying Mutual Funds
Chapter 6: Tracking and Selling Mutual Funds

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Chapter 1: Introduction to Mutual Funds
- How Does a Mutual Fund Work
- Why Invest in Mutual Funds

Chapter 1: Introduction to Mutual Funds

A mutual fund is a pool of funds which are invested in a diversified portfolio of stocks and other instruments. This pool of funds is usually gathered from a large number of investors. Each investor gets a share of the mutual fund in proportion to the amount of money he has invested in it.

How Does a Mutual Fund Work

The investment company which offers the mutual fund outlines a general investment strategy for each fund that it manages. There are many different kinds of funds with different investment strategies so that investors can choose based on their desired risk-return preference.

For instance, an equity fund may give higher returns with an investment strategy focused on equity. This means that the risk is also higher, though not as high as an amateur investor investing in equity. Investors select mutual funds based on their investment goals and risk appetite.

A mutual fund also typically has an expected return, which is advertised at the time of its launch. This return is what the mutual fund managers hope to consistently get with the investment strategy they have outlined.

The actual investments are made and managed by a fund manager hired by the investment company. To achieve the promised returns and to keep the risk within the outlined level, the individual investments within the fund may be sold off or new ones bought by the fund manager.

An investor can opt out of a mutual fund by selling it like a stock. If he stays invested, he can get returns in the form of annual distributions. The distributions are nothing but the total income gained on the various investments made by the fund, which is paid back to the shareholders. The fund may also have some capital gains from securities sold off at a profit. These gains are also passed on to the investor. The investor can choose to automatically reinvest such proceeds or get them back as a cash payout.

Why Invest in Mutual Funds

Millions of Americans invest in mutual funds every year. Although, like all other investments, mutual funds also have an element of risk, they are still a very popular investment avenue. So what makes the mutual fund so popular?

  • Pooling of Resources: Mutual funds enable small investors to get a share of a large portfolio. This makes a huge amount available for investing in larger projects and investments which may be out of reach of individual investors. This availability of a large amount of funds also means you need to pay only a very small proportion of the processing costs for any transactions.

  • Managed by Experts: For those investors who are not experienced, a mutual fund is a great option. Your lack of knowledge of markets need not compromise the safety of your investments. The fund will be managed by a knowledgeable fund manager who will be an expert in investing. The manager uses his experience to invest your funds in the right places at the right time. The investor simply has to sit back and enjoy the rewards of the expert’s efforts.

  • Diversification: A mutual fund is a diversified investment option and it lets you spread your risk over many different securities. A well diversified portfolio has a lower risk than a concentrated one and this advantage of lower risk is passed on to you with a mutual fund.

  • Simple and Effective: Mutual funds offer a simple and effective way to invest in stocks, shares and other securities. The gains can be very attractive if you invest in the right kind of fund. You can simply sell the fund if necessary just as you would sell a share.

Next Chapter: Categories of Mutual Funds