Mutual funds allow a group of investors to combine their cash and invest it. By pooling their money together, mutual fund investors can sample a broader range of stocks or bonds than they could if they were trying to buy the stocks and bonds on their own. When you buy a mutual fund, you're actually buying an ownership stake in a corporation that in turn hires a fund manager to invest its money. The price of a single ownership stake in a fund is called its net asset value, or NAV.
The fund manager combines your money with that of other investors. Taken altogether, those investments are called the fund's assets. The fund manager invests the fund's assets, typically by buying stocks, bonds, or a combination of the two. Some funds buy more complicated security types. These stocks or bonds are often referred to as a fund's "holdings," and all of a fund's holdings together are its "portfolio."
A fund's type depends on the kinds of securities it holds. For example, a stock fund invests in stocks, while a small-company stock fund focuses on the stocks of small companies. What you get as an investor or shareholder is a portion of that portfolio. Regardless of how much or how little you invest, your shares are the portfolio in miniature.
Mutual funds are not insured or guaranteed. You can lose money in a mutual fund, because a fund's value is based on the value of all of its portfolio holdings. If the holdings lose value, so will the fund.
Mutual funds are good investments for those who don’t have the money, time, or interest necessary to compile a collection of securities on their own. Mutual funds offer some notable benefits to investors.
If you had just $3,000 to invest, it would be difficult for you to assemble a varied basket of stocks or bonds on your own. If you bought a mutual fund, though, you would be able to sample many more types of stocks or bonds with that same $3,000. You can make an initial investment in several funds with just $3,000 in hand. You can even buy some funds for as little as $100 per month if you agree to invest a certain dollar amount each month.
Whether you’re buying funds on your own or hiring a broker or financial planner to do it for you, funds are easy to buy. Once a fund company has your money, it often takes just a phone call or mouse click to buy shares in a fund. By the same token, it's also easy to sell a fund. Unlike many other security types, such as individual stocks, you don’t need to find a buyer when it's time to unload your shares. Instead, the vast majority of mutual funds offer daily redemptions, meaning that the fund company will give you cash whenever you're ready to sell. Investors who own closed funds can also sell at any time.
The government put safeguards in place for investors through regulation set by the Investment Company Act of 1940 (often called "the '40 Act"). Your mutual fund is a regulated investment company (regulated by the Securities & Exchange Commission) and you, as a mutual fund investor, are an owner of that company. As with other types of companies, mutual funds have boards of directors that represent the fund’s shareholders.
If you plan to buy individual stocks and bonds, you need to know how to read a company's cash-flow statement or assess the likelihood that a given company will fail to meet its debt obligations. Such in-depth financial knowledge is not required to invest in a mutual fund, however. While mutual fund investors should have a basic understanding of how the stock and bond markets work, you pay your fund managers to select individual securities for you.