Mutual Fund definition
A mutual fund is a collection of stocks, bonds and other securities. These are investments traded on a secondary market. Once you buy into a mutual fund, you own a share of it, and the price of each is known as the net asset value (NAV). This is essentially the total value of all the securities it owns divided by the number of the shares. Mutual fund shares are traded all the time, and at the end of each business day, their price will have adjusted.
What is a mutual fund?
So, we’ve established that mutual funds are a financial vehicle comprising a pool of money from a number of investors. This is then invested in securities like stocks, bonds, money market instruments and other assets. The underlying security types, also known as holdings, combine to form one mutual fund, which can also be known as a portfolio. They are operated by money managers who assign the fund’s assets with the goal of producing capital gains or income for the investors.
Mutual funds provide a way for small or individual investors to access professionally managed portfolios of equities, bonds and other securities. Therefore, each shareholder is involved in the gains or losses of the fund, depending on the proposition of their investment. A mutual fund’s performance is measured by changes in its total market capital that comes from the combined performance of all of the investments.
Still confused? The Balance provides an analogy to explain mutual funds a little simpler. Imagine that mutual funds are like baskets. In every basket there are certain types of stocks, bonds or a combination of stocks and bonds to form one mutual bond portfolio. For example, an investor who buys a fund called ABC International Stock is buying one investment security (the basket) that holds tens or hundreds of stocks from across the globe.
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Something to Remember
The investor doesn’t actually own the securities, but instead, a representation of them. And, they own shares of the mutual fund not shares of the securities. For example, if a mutual fund included shares of stock in McDonald’s as well as other portfolio holdings, the investor does not directly own McDonald’s stock. They own shares of the mutual fund. That being said, they would still benefit from the appreciation of the shares in McDonald’s.
Why are mutual funds a popular type of investment?
Mutual funds are the most popular investment type because they are simple to understand and easy to use. Mutual funds’ simple nature, combined with their versatility, accessibility and easy-to-understand structure are attractive features for beginner investors. But they are also powerful investment vehicles for a range of investor-types. They are suitable for a variety of savings and investment goals, for example university and retirement.
As mutual funds can hold thousands of stocks or bonds they are known as diversified investments. Diversification is essentially the same as strength in numbers; the concept helps the investor because it reduces the associated risk. Buying individual securities often comes with higher market risk.
Let’s look at some of these advantages in more depth below.
Seven Advantages of Mutual Funds
- Diversity
Buying shares in a mutual fund means you don’t have to have all your eggs in one basket. You can diversify your investment across numerous securities and so if one investment decreases in values, another investment in the portfolio might rise. Without the use of a mutual fund, an investor may need to buy over 20 securities to reach a good level of diversification.
- Professional Management
Mutual funds offer investors access to professional money managers who have heaps of expertise in the industry and have resources to buy, sell and monitor investments. Most private, non-institutional money managers deal with high-net worth individuals (people with at least six figures to invest). However, mutual funds, as we’ve mentioned require much lower investments.
- Liquidity
The majority of mutual funds let you sell your fund shares any day the stock markets are open. This means you have easy access to your money.
- More Affordable
For many of us it would be more expensive to purchase all of the individual securities that are held by a single mutual fund directly. In comparison, the minimum initial investments for the majority of mutual funds are less pricey. When you redeem your shares, their value may be more or less than their original cost.
- Simplicity
Many investors lack the time, knowledge and resources to create their own portfolio of stocks and bonds. Buying shares of a mutual fund allows an investor to own a professionally managed, diversified portfolio without actually having any knowledge of investing strategies.
- Versatility
There is an extensive range of mutual funds that investors can choose from in almost any market sector imaginable. Sector funds are a way for investors to buy into focused market areas, for example technology, healthcare, social media and financials. Investors can also choose the asset type, including oil, gold and other natural resources. Therefore, this inherent versatility can further the investor’s portfolio as it grows.
- Accessibility
An investor can get started investing in mutual funds with a relatively small amount. As we’ve mentioned, investors have access to a large number of investable securities with a mutual fund investment.
Types of Mutual Fund
The majority of mutual funds fall into one of following categories:
- Equity Funds
- Fixed Income Funds
- Multi-Asset Funds
- Alternative Funds
- Index Funds
- Balanced Funds
- Money Market Funds
- International Funds
- Speciality Funds
