A mutual fund is an investment vehicle made up of a pool of money collected from
many investors for the purpose of investing in securities such as stocks, bonds,
money market instruments and other assets. Mutual funds are operated by
professional money managers, who allocate the fund's investments and attempt to
produce capital gains and/or income for the fund's investors. A mutual fund's
portfolio is structured and maintained to match the investment objectives stated in
A mutual fund is a collection of stocks, bonds, or other securities. When you buy a
mutual fund, you own the share of the mutual fund. The price of each mutual fund
share is called its NAV or net asset value. That's the total value of all the securities it
owns divided by the number of the mutual fund's shares.
A fund diversifies holding many securities. This diversification decreases risk.
Shareholders of open-end funds and unit investment trusts may sell their holdings
back to the fund at regular intervals at a price equal to the net asset value of the
fund's holdings. Most funds allow investors to redeem in this way at the close of
every trading day.
Professional investment management
Open-and closed-end funds hire portfolio managers to supervise the fund's
Ability to participate in investments
that may be available only to larger investors. For example, individual investors often
find it difficult to invest directly in foreign markets.
Service and convenience
Funds often provide services such as check writing.
Mutual funds are regulated by a governmental body.
Transparency and ease of comparison
All mutual funds are required to report the same information to investors, which
makes them easier to compare to each other.
Like many other investments without a guaranteed return, there is always the
possibility that the value of your mutual fund will depreciate. Equity mutual funds
experience price fluctuations, along with the stocks that make up the fund. The
Federal Deposit Insurance Corporation (FDIC) does not back up mutual fund
investments, and there is no guarantee of performance with any fund.
As you know already, mutual funds pool money from thousands of investors, so every
day people are putting money into the fund as well as withdrawing it. To maintain
the capacity to accommodate withdrawals, funds typically have to keep a large
portion of their portfolios in cash. Having ample cash is great for liquidity, but money
sitting around as cash is not working for you and thus is not very advantageous.
Mutual funds provide investors with professional management, but it comes at a cost
– those expense ratios mentioned earlier. These fees reduce the fund's overall
payout, and they're assessed to mutual fund investors regardless of the performance
of the fund. As you can imagine, in years when the fund doesn't make money, these
fees only magnify losses
Many mutual fund investors tend to overcomplicate matters – that is, they acquire
too many funds that are highly related and, as a result, don't get the risk-reducing
benefits of diversification; in fact, they have made their portfolio more exposed, a
syndrome called diworsification. At the other extreme, just because you own mutual
funds doesn't mean you are automatically diversified. For example, a fund that
invests only in a particular industry sector or region is still relatively risky.
Lack of Transparency
One thing that can lead to diworsification is the fact that a fund's purpose or makeup
isn't always clear. Fund advertisements can guide investors down the wrong path.
The Securities and Exchange Commission (SEC) requires that funds have at least 80%
of assets in the particular type of investment implied in their names; how the
remaining assets are invested is up to the fund manager.
Researching and comparing funds can be difficult. Unlike stocks, mutual funds do not
offer investors the opportunity to compare the P/E ratio, sales growth, earnings per
share, etc. A mutual fund's net asset value gives investors the total value of the
fund's portfolio, less liabilities, but how do you know if one fund is better than
7 Reasons you should invest in Mutual Funds
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Systematic Investment Plan
Why it is important to have mutual funds in investment portfolio