A mutual fund is a single investment entity that is like a basket of stocks. A single mutual fund actually invests in hundreds, or even thousands, of other stocks. By owning one share of the mutual fund, you actually own a small slice of all these other companies.
How a Mutual Fund Works
As explained above, a mutual fund is a basket of stocks. A mutual fund is an instrument that is created by a mutual fund manager with a specific investing goal in mind. For example, there could be index mutual funds, which mimic major indexes like the S&P500 or the Dow Jones Industrial Average. There are also mutual funds that invest in specific sectors or areas of the market: like small cap stocks or even international stocks.
The fund manager then uses the prospectus as a guide to make investment decisions for the fund. As an owner of a share in the fund, you get a slice of all of the underlying stocks in the fund. You also pay the manager a fee from your investing profits each year (called an expense ratio). If the fund earns dividends or other profits from the underlying investments, it pays those dividends and capital gains to fund shareholders.
Mutual funds, unlike Exchange Traded Funds (ETFs), only trade once per day, and the end of trading, and their price is calculated based on the prices of the underlying investments.
When To Use It To Invest
Investing in a mutual fund can be a great way to get started investing. Mutual funds can provide low cost ways to diversify a portfolio. For example, if you want a balanced portfolio of 50% stocks and 50% bonds, investing in a stock mutual fund and a bond mutual fund could achieve this for you.
When investing money in a mutual fund, it is important to pay attention to the fees being charged. Index funds, which don’t trade very often, typically have much lower fees than actively managed funds, which tend to trade very frequently. Also, make sure that, if you pick an actively managed fund, you research the fund manager and understand what his investment philosophy is.