Investors have a range of assets to choose from when building their portfolios. Among them, mutual funds offer several benefits, such as diversification, that can help your reach your financial goals. However, they also have risks to consider.
Learn more about what mutual funds are, how they work, about the advantages and potential downsides, and how to invest in them.
What Are Mutual Funds?
Mutual funds are investment vehicles in which investors pool their money with other investors to buy a collection of securities, which can include stocks, bonds, short-term money market instruments or other assets. The combination of securities is typically managed by a professional investment advisor.1
Each share of a mutual fund represents a proportion of ownership in the fund’s portfolio and its income. Shares are priced at the end of each business day, typically after major U.S. exchanges close.
Buying into a mutual fund allows you to get exposure to many assets at once. This diversification lowers your risk because when your holdings have a greater mix of assets, your portfolio is protected from being wiped out if one asset fails.
Mutual Funds vs. Index Funds and ETFs
Mutual funds are similar to index funds and exchange-traded funds (ETFs) in that they offer a way to invest in many assets at once to improve diversification. However, they have some key differences.
An index fund holds a basket of securities that mirror the assets in a particular index, such as the S&P 500 Index or the Dow Jones Industrial Average. It essentially aims to replicate the performance of the index by holding all or a sample of its assets. An index fund can be a mutual fund, however it may also be an ETF.2
Exchange-traded funds are funds with shares that trade over a stock exchange like the New York Stock Exchange (NYSE) or Nasdaq. Like with stocks, ETFs have share prices that change throughout the trading day according to market demand. You can invest in an ETF for as low as the price of one share.3
Pros and Cons of Mutual Funds
Mutual funds offer investors several benefits, including a way to diversify and lower risk. Investing in them can save time compared to buying and selling many individual assets to achieve similar diversity.
Mutual funds also offer the advantage of potentially providing investors with returns that can help them meet their financial goals. They offer diversification, so they tend to be lower risk than individual stocks.4 You also get the advantage of professional management over the assets in the fund, which can save time required for researching investment choices. Finally, dividends from a mutual fund can be reinvested to purchase more shares, which can potentially generate more profit.
But mutual funds also have downsides to keep in mind as well. For one, they often charge management or other fees, which can impact your earnings. Like with any investment, there is no guarantee you will make money, and you could even lose money if the underlying companies face financial challenges. You will also have no control over which assets are held in the mutual fund.
How to Invest in Mutual Funds
Investing in mutual funds is different from investing in stocks or ETFs that you can buy over an exchange for as low as the cost of a share. Instead, with mutual funds, you buy shares from the fund itself, and you sell your shares back to the fund. You can also buy mutual fund shares through investment professionals.
You’ll typically have a minimum investment requirement for mutual funds, which can range from hundreds to thousands of dollars. Although, you can find mutual funds with no minimum investment requirement.
The Bottom Line
Mutual funds are a popular investment choice for investors saving for retirement or other financial goals. Assets within a fund can vary widely as each mutual fund focuses on a different industry or asset class. Each fund also has its own terms and fees, so weigh the pros and cons of any fund you are considering buying. Compare expense ratios and read the fund’s prospectus as well.
Have Questions About Investing?
Talk to a qualified financial advisor today to get professional advice today. Need help finding a financial advisor in your area? Give us a call today so we can match you with an advisor who will put your needs first.
Investing in mutual funds is subject to risk and loss of principal. There is no assurance or certainty that any investment strategy will be successful in meeting its objectives.
4 Office of Financial Readiness, “Investing Basics: Bonds, Stocks, Mutual Funds and ETFs,” https://finred.usalearning.gov/Saving/StocksBondsMutualFunds |
