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What Is Mutual Fund - What is a Mutual Fund?

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A mutual fund is one of the most common types of investments, right up there with stocks and bonds. However, many people don’t know what, exactly, a mutual fund is. Most people are content with not knowing until they begin to think about their future and their current investment strategy. One of the most commonly asked questions that financial advisors get asked is, “What is a mutual fund?”

When people ask, “what is a mutual fund?” they usually have a vague idea that it has something to do with the stock market. In fact, mutual funds have everything to do with the stock market. Mutual funds were originally introduced as a way for common people with little knowledge of the stock market to invest in the stock market. They are meant to be a way to simply put up some capital as an investment, sit back, and let it grow.

Simply put, what a mutual fund is, is a collection of stocks and bonds maintained by a group or company. The group or company uses investor’s funds to enlarge their existing mutual fund portfolio. Each investor receives a number of shares in the mutual fund, depending on the amount of money they invest. Unlike regular stocks, shares in a mutual fund are unlimited. New shares are issued with each new investment.

Money is made from mutual funds in three different ways:

  1. Dividends and Interest – All dividends on stocks and interest on bonds is divided up into the shares of the mutual fund and paid out in regular intervals.
  2. Capital Gains – As the mutual fund group maintains the fund, it may sell some stocks and bonds and purchase others. Any profit made from the sale is distributed to shareholders.
  3. Price Increases – As the stocks and bonds in the mutual fund increase in price, so does the value of the mutual fund shares. Shares can be sold to make a profit.

Mutual funds were once thought to be totally advantageous, but a number of disadvantages have become apparent throughout the years.

Advantages

  • Mutual funds are managed by a group of professional investors with first-hand knowledge of the stock market and the economy. If you cannot afford a personal financial advisor or you don’t have time to research stocks, mutual funds are a cheap and easy way to obtain professional management of your investment.
  • Mutual funds are composed of a diverse portfolio of stocks and bonds. This level of diversification is only obtainable with large investments that you may not be able to afford. This diversification helps you to minimize losses in a shifting market.
  • Transaction costs for mutual funds are lower than for regular stocks and bonds because they are done by the group.
  • Mutual fund shares can be sold and converted to cash at any time.
  • The minimum investment in a mutual fund is relatively small. An investment portfolio utilizing a mutual fund can be started for as little as $100.

Disadvantages

  • There is no consensus that professional financial agents are better at trading stocks and bonds than anyone else. The mutual fund group can make bad investments and lose money as easily as anyone else.
  • The expenses of the mutual fund group are passed on to the investors. This means you are paying above and beyond the actual costs of the individual stocks and bonds. Fees vary from mutual fund to mutual fund.
  • Mutual funds can suffer from being overly diluted. When one stock goes through the roof, the return to the fund is small because there may be too many other stocks and bonds in the fund.

Now that you have answered your question on “what is a mutual fund,” you may be ready to invest in one. Buying mutual funds is accomplished in different ways. Some mutual funds sell shares directly. Other funds only sell their shares through brokers or other partners that may include banks, financiers, or even insurance agents.

One of the most popular ways to buy mutual funds is through what is known as a “fund supermarket.” These are brokers that provide a choice of several funds that can be purchased without any transaction fees. Many of these fund supermarkets have a consolidated reporting system that can be accessed by accountholders online. This allows investors to check how their funds are doing individually and as a group. These large brokerages will often have informational resources that can be used to choose funds in which you would like to invest.

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