According to Investwords.com, a mutual fund is an open-ended fund operated by an investment company which raises money from shareholders and invests in a group of assets, in accordance with a stated set of objectives.
In simpler terms, mutual funds are investment vehicles that combine several stocks, several bonds, or both, are professionally managed and have their ownership shared among many shareholders. Mutual funds present a simple way to invest, since the holdings and allocations are chosen by professional managers and an investor can purchase a unit relatively inexpensively. This allows people who don’t understand investing or don’t have a lot of money to invest to still participate in the market.
There are 2 basic types of mutual funds: fixed and equity. Fixed mutual funds combine fixed investments, namely cash and bonds, in various proportions, while equity mutual funds are primarily comprised of stocks. There are also 2 types of equity funds: growth and income. Growth funds aim for a higher rate of return, so they often purchase stocks of younger, growth oriented companies. Income funds, on the other hand, invest in more established companies that pay dividends to shareholders, hence the name. Specialty funds, such as Energy, Hi Tech and Healthcare invest in companies in their respective industries.
Another popular mutual fund type is money market fund. It consists of what’s called a fixed account, where money is kept in cash. It usually has low or no fees and a fairly conservative but stable rate of return. Index funds are also pretty common, especially in 401k accounts. These funds basically trail the market: they invest in the same stocks that are included in major indexes such as S&P and Dow Jones Industrial average.
Because they are professionally managed, mutual funds come with fees. Depending on different fund structure, different fees are assessed. Front load funds assess fees when an investor purchases a unit; thus they are called sales charges. Back load funds assess fees when an investor sells his or her funds. Management fees are assessed annually and are supposed to cover management and marketing expenses and financial advisor commissions. Some funds don’t charge 12b-1 fees – they are called no load funds. Recently Securities and Exchange Commission has been considering changes to 12b-1 laws; mainly aimed at eliminating them altogether. The premise is that consumers shouldn’t be charged 12b-1 fees when they already pay front and back loads when buying and selling funds.
Consider your investment objectives, time horizon and risk tolerance before choosing a fund. Also remember that when it comes to mutual funds, returns are not guaranteed. Though a tedious and neglected task, reading a prospectus is a very wise idea. It can not only help you understand the investment objective and philosophy of a certain mutual fund company, but also allow you the opportunity to learn about asset allocations and returns history of each fund, the track record of the fund managers and special risk considerations.