What is a Mutual Fund?

Mutual funds often carry a veil of sophistication that leaves prospective investors confused and unsure. By taking the time to understand mutual funds, new investors are able to take their first steps in investing and building their nest egg.

A mutual fund is actually a basket of investments, which can include stocks, bonds, government securities and even other mutual funds. When you invest in a mutual fund, you do not directly own the investments in the fund, but the gains and losses of that fund translate to gains and losses for you.

Mutual funds are often a part of one’s investment portfolio because they allow investors to hold a group of investments in one package. It also allows them to diversify their portfolios so that they are not heavily dependent on a handful of individual investments.

Each mutual fund has its own area of emphasis. Some mutual funds may be focused on stocks of large companies in the United States, while others may invest entirely in foreign bonds. There are even mutual funds that aim to find investments that will lose value over time. Mutual funds that are known as “index” funds will try to mimic the performance of stock market indices, such as the Dow Jones or S&P 500.

A fund manager chooses the appropriate investments of the mutual fund to generate a return. Investors may research a fund manager’s past performance to decide whether they want to invest in a certain mutual fund. Some funds, such as index funds, use a preset formula for selecting investments.

The cost of investing in a mutual fund may include an annual expense (known as the expense ratio) and transaction fees, which vary from fund to fund. These costs apply whether or not the mutual fund experiences a return.

You can invest in mutual funds in a taxable account an, individual retirement account (IRA) or other investment vehicles. However, each brokerage or mutual fund firm may have its own selection of mutual funds from which investors can pick.