Published: July 2015
are investment vehicles commonly employed by many Americans -- in fact, there's more than $15 trillion invested in 9,000 funds in the U.S, according to Statista
Mutual funds are a common offering in many company-sponsored 401(k) plans. If you're working on your retirement savings plan, it can help to understand the basics of mutual funds, to see whether they're an option you might want to invest in.
According to the Securities Exchange Commission (SEC), a mutual fund is a company that pools money from many investors and invests it in stocks, bonds, and/or other securities. This creates a portfolio of holdings, of which investors can purchase shares. Each share represents an investor's partial ownership of the fund's portfolio, and the right to enjoy proportional gains or income from those holdings. In short, when you invest in a mutual fund, you are entitled to a share of any gains (or losses), such as dividends, interest income, says the SEC.
One of the many benefits of mutual funds, says the Financial Industry Regulatory Authority (FINRA), is built-in diversification — that is, mutual funds can invest in a wide variety of securities, thus reducing the investment risk associated with having all or most of your money in a single investment. By owning mutual fund shares, you can spread your money across a variety of stocks or other securities.
Generally speaking, FINRA says, mutual funds can be classified in the following ways:
- Stock funds invest in stocks. Some funds may seek to cover only a certain industry or sector, such as technology or health care, while other stock funds may seek broader diversification across an entire market index, such as the Standard & Poor's 500 or NASDAQ. Still others might invest in certain world regions, such as a Europe or Asia stock fund.
- Bond funds, as the name suggests, invest in in bonds. Like stock funds, they may focus on any particular type of bond, such as municipal or global bonds, for example.
- Balanced funds invest in a combination of stocks and bonds.
One other mutual fund distinction to note is whether a fund is actively or passively managed.
When a fund is actively managed, says FINRA, it employs professional portfolio managers to select the investments, with the goal of out-performing the market. Such funds might be a good choice for investors who seek professional selection and management of their fund's investments. The SEC and FINRA note, however, that actively managed funds often have higher fees, in part due to the professional portfolio management.
By contrast, notes FINRA, passive funds aren't actively managed — instead, they merely seek to mirror and replicate (not beat) the returns offered by the index they track. For example, the manager of a fund that mirrors the S&P 500 would just buy a portfolio of the stocks in that index in the same proportions to replicate the S&P 500's holdings. Since the fund merely mirrors the index — and doesn't employ professionals to make active investment choices — passive funds such as these often have much lower fees.
Ultimately, the question of which mutual fund — or funds — to invest in is a highly personalized one based on your individual risk tolerance and other financial factors. And since mutual funds are offered in most 401(k) or self-directed IRA plans, they're also a convenient starting point for retirement investing.
Speak with your financial professional and consult a fund's information packet, known as its prospectus, before deciding which funds are right for you.