A mutual fund is a pool of money that is professionally managed for the benefit of all shareholders. As an investor in a mutual fund, you own a portion of the fund, sharing in any increases or decreases in the value of the fund. A mutual fund may focus on stocks, bonds, cash, or a combination of these asset classes.
The beauty of mutual funds
Mutual funds offer a number of advantages, including diversification, professional management, cost efficiency, and liquidity.
- Diversification. A mutual fund spreads your investment dollars around better than you could do by yourself. This diversification tends to lower the risk of losing money. Diversification usually results in lower volatility, because when some investments are doing poorly, others may be doing well.
- Professional management. Many people don't have the time or expertise to make investment decisions. A mutual fund's investment managers, however, are trained to search out the best possible returns, consistent with the fund's strategies and goals. In essence, your mutual fund investment brings you the services of a professional money manager.
- Cost efficiency. Putting your money together with other investors creates collective buying power that may help you achieve more than you could on your own. As a group, mutual fund investors can buy a large variety and number of specific investments. They can also afford to pay for professional money managers and fund operating expenses.
- Liquidity. With most funds, you can easily sell your fund shares for cash.
You can buy shares a few different ways, depending on the rules of the particular fund. Funds are often described as either being "no-load" or "load" funds, depending on whether or not they charge a sales commission.
- No-load funds: Many funds are no-load funds that charge no (or a very low) sales fee or commission. Financial companies typically sell no-load funds directly to investors in places like newspapers and magazines. In this case, you complete all the paperwork yourself.
- Load funds: These funds charge a sales fee or commission for purchases. Some funds charge the fee when you buy shares; others charge when you sell them. Brokerage firms and banks often sell load funds, and will help process any paperwork.
There are reputable, high-performing funds in both categories. Because sales charges reduce your return, you should consider no-load funds whenever possible.
Most funds offer plans that allow you to automatically transfer set amounts on a regular basis from your bank account or paycheck. This is a great way to save money on a routine basis.
With automatic investing, you get the benefits of dollar cost averaging. That is, when you make regular investments in a mutual fund, such as investing $100 every month, you can take advantage of both the ups and downs of the market.