A mutual fund is a pool of money provided by individual investors, companies, and other organizations. A mutual fund, or portfolio manager is hired to invest this money (the fund’s assets) in stocks, bonds or other investment securities (or a combination of stocks, bonds and securities). What the portfolio manager buys and sells is dictated by the fund’s prospectus. The prospectus spells out exactly what the manager can and can not buy. It clearly states the style and objective of the fund. For example, if the prospectus states that the fund is an American Large Cap Equity Growth fund, than you know the manager can only invest in the stock of large American companies and the goal is long term growth.
Professional Money Management
Used in most retirement plans, you may own mutual funds without even realizing it. According to the Investment Company Institute, over 92 million people in the U.S. (about 45% of U.S. households) owned mutual funds in 2008. This type of investment is perhaps the easiest and least stressful way to invest in the market. Before diving in and selecting a mutual fund, an investor should know exactly what they are and how they work.
Mutual funds start with the portfolio manager and his/her team of analysts. These professionals spend years learning their craft and have the degrees and designations to prove it. Most funds are “actively managed.” Compared to an “Index Fund,” such as the S&P 500 Index, the manager and analysts monitor the investments in the portfolio constantly. They analyze financial statements, watch trends and keep an eye on the news for anything that might affect the fund. Because this is his or her primary occupation, they can devote much more time than an individual investor. This should provide the peace of mind of being an informed investor without stress of researching the investments and calculating the risks.
Diversification
With a mutual fund, a small amount of money can be invested in one fund and the investor still obtains instant access to a diversified portfolio. In order to diversify a portfolio buying individual stocks or bonds, that same investor have to invest more time, money and research. This exposes that person to more risk and difficulty.
Using a mutual fund compared to an individual investment helps an investor to follow a basic principal of investing:
Don’t put all your eggs in one basket.
Many different types of investments in one portfolio decrease the risk of loss from any one of those investments. For example, if an investor put all of their money into Bear Stearns stock, they lost all of their money. On the other hand, if the money was invested in a mutual fund that owns many different stocks, it is more likely that the investment will grow over time. At the very least, owning Bear Stearns in the fund will not mean that the entire investment is lost.
Variety of Funds
With over 10,000 mutual funds to choose from, an investor can usually find whatever they are looking for. They can choose mutual funds that invest in stocks, bonds, cash instruments or a combination of all three. There are funds that follow a specific index. There are more actively managed funds where the goal is to do better than the index. There are regional, sector and specific goal-oriented funds.
The many different types of mutual funds available, allows an investor to build a diversified portfolio at minimal cost and without much difficulty. While there are so many investment options (individual stocks, ETFs, and close-end funds, etc.) mutual funds offer a simple, efficient way to invest for retirement, education or other financial goals.