What Exactly Is a Mutual Fund?

In financial conversations, you may hear the word “mutual fund” come up from time to time. But what exactly is a mutual fund? And how do investors use them?

Well, let’s start by sharing that a mutual fund company gathers money from investors and invests it on their behalf. Because of the larger scale, a mutual fund typically offers diversification within its asset class and is often managed by a professional investment manager. Each individual investor pays towards the cost of that professional management via the funds ‘expense ratio’. Mutual funds offer investors the ability to have their money professionally managed and fully diversified.

This sounds great, but keep this in mind: not all mutual funds are right for you, which is why it’s important to have a financial advisor to help you choosing one that’s in alignment with your goals. That being said, let’s dive into what exactly mutual funds are and how they can benefit you.

The basics of mutual funds

Let’s start by saying hand-selecting and buying individual stocks takes up valuable time. The research, combined with weighing out your options and implementing within the context of a greater portfolio, can take up some serious time—and, if you aren’t careful you may be exposing yourself to risks that you’re not even aware of.

That’s where the appeal of mutual funds comes in. They get rid of the need to do all that research—instead, you just invest in a mutual fund and the company takes care of the rest.

What to know about investing in mutual funds

An example of contributing to a mutual fund is when you fund a 401(k) plan. With these plans, the investor only has to choose the fund company and the fund. Sounds simple enough, but it’s actually a huge decision to make. One of the biggest things to pay attention to is the mix of stock and bonds a mutual fund holds, as that can give you an idea of risks and returns.

What to know about mutual fund companies

Fidelity, Vanguard, and American Funds are all big mutual fund companies. Mutual fund companies come in may shapes and sizes, and not all are created equal.

When you’re comparing mutual fund options, a great way to start the comparison is to look at expense ratios, which tells you the percentage of a fund’s assets that the company keeps to cover expenses. The lower that ratio is, typically, the lower the fees—which means more of your money gets to be invested.

What about no-load mutual funds?

Now, a mutual fund that charges a sales fee or commission is called a load fund. On the flip side, a fund that doesn’t charge you a sales commission is called a no-load mutual fund. A load fund’s charges may have to be paid upfront, or in upcoming years when shares are sold. Keep in mind, though, that a no-load fund could also have higher fees, so be sure to check the expense ratio to get a sense of what you’ll get.

Wrapping up mutual funds

For those looking for a hands-off approach to investing, mutual funds are great options to look into. However, it’s important to understand exactly how the fund works, what you’ll get out of it, and what you’ll be charged. It’s your money, after all—the last thing you want to do is have it be eaten up by fees you didn’t even realize you were being charged. Taking a smart and strategic approach with mutual funds can be a great way to grow your investments.