What Are Mutual Funds?
A mutual fund is a company that invests its shareholders’ money in stocks, bonds and money market instruments. When you buy shares in a fund, your money is combined with that of thousands of other people with similar investment goals. The fund hires a professional investment manager to invest the money and monitor the investments daily to make sure they continue to meet the fund’s – and the shareholders’ – goals.
Why Are Funds So Popular?
For three basic reasons: professional investment management, diversification and convenience.
Professional Management: A fund lets you take part in the stock and bond markets without worrying about which securities to buy or sell. The fund’s investment manager- a person who spends every working hour trying to find the best investments- makes all those decisions for you.
Diversification: While there is not a 100% safe investment, a multimillion-dollar fund can reduce risk by spreading investments among dozens or even hundreds of different securities- an advantage most people could not achieve.
Convenience: The fund does all the bookkeeping for your account. You may invest more money whenever you wish. You may redeem all or a portion of your shares at anytime at the current net asset value.
How Mutual Funds Work
The principle behind Mutual Funds is simple. You pool your money with many other individuals into a fund. The fund buys shares in a group of stocks. A professional fund manager oversees the selection, purchase and sale of the stocks themselves. Details such as enrolling you in the program, accounting and reporting your earnings and losses to you are handled by the fund administrator.
Purchasing Mutual Funds
Because they offer convenience, professional management and diversity, mutual funds have become one of the most popular forms of investment in the 90’s. They are offered by many banks and investment groups. You can also buy shares in mutual funds direct from the fund itself.
One of the benefits of mutual funds is that you do not have to buy a “block” of shares, as you do on the stock market. You can round off your investment to an amount such as $500 and own an odd number of shares, or even a portion of a share. Another benefit of mutual funds is that with most funds, you can add to your initial investment over time. Funds are either open-end or closed-end. With an open-end fund, anyone can buy into a fund at any time. And they can make additional purchases of shares at any time. A closed-end fund starts by issuing a limited number of shares. Once they’ve all been issued, you must buy existing shares from another investor through a broker.
There are costs associated with owning shares in a mutual fund. Unless you purchase a no-load fund, you will pay a fee, known as a “load”, upon either purchase or redemption of your shares. There are also annual fees to cover the funds operating expenses. These are all discussed in on the Fees page.
What About Risk?
Mutual funds are securities, not savings accounts. They are regulated by the Securities and Exchange Commission (SEC), and are not insured by the FDIC. Because their value hinges on the value of the stocks they own, they always carry some risk. The amount of risk depends on the type of fund, which can range from very conservative to very aggressive, and the stock market as a whole. Their behavior follows that of the stock market, or, if they’re a specialized fund, the behavior of the market segment they represent. A significant rise in the Dow or a significant correction is going to affect any fund considerably.
Because of the risk you are taking, it is very important that you do your homework. And before you invest, obtain a copy of the prospectus and study it carefully.
Tracking Your Investment
The fund will send you period reports. These will detail the number and value of shares you own. You can also track the value of your shares in the mutual funds lists of national papers like the Wall Street Journal, Investors Business Daily and USA Today.
Know The Terms
Net Asset Value (NAV): The total value of all the securities a fund owns, minus operating costs, divided by the number of outstanding shares. Prices are generally listed without the dollar sign. To read them, just imagine putting a dollar sign before the number.
Offer Price: What you actually pay for your shares. If this is higher than the NAV, it includes a front-end load. If you’ve added to your initial investment with subsequent purchases of shares, the offer price for the subsequent shares will be different from those purchased with your initial investment. It’s important to keep track of the date and amount of each investment, so you have a good understanding of how much your shares have grown.
NAV Change: You will see this term on lists of mutual funds in papers like the Wall Street Journal. It refers to how much the price of an individual share increased or decreased since the market close of the previous day. The amount always has a plus or minus next to it.
Liquidity: Mutual funds are very liquid. The fund will buy back shares at any time.