Mutual Funds

Mutual funds

What's a mutual fund?

A mutual fund, also referred to as an open-end fund, is an investment company that spreads its money across a diversified portfolio of securities -- including stocks, bonds, or money market instruments. 

Shareholders who invest in a fund each own a representative portion of those investments, less any expenses charged by the fund. 

Mutual fund investors make money either by receiving dividends and interest from their investments, or by the rise in value of the securities. Dividends, interest and profits from the sale of any securities (capital gains) are passed on to the shareholders in the form of distributions. And shareholders generally are allowed to sell (redeem) their shares at any time for the closing market price of the fund on that day. 

Why invest in mutual funds?

There are a variety of reasons why investors might choose mutual funds over other investments, such as individual stocks and bonds. The number one reason is diversity, which can both increase your potential returns and decrease your overall risk. 

Mutual funds allow an investor to spread out his or her money across as few as a handful to as many as several thousand companies at one time. 

Funds can be especially advantageous for small investors who would be forced to pay enormous transaction fees if they bought the securities individually, and for investors who either don't have the time to research their own investments or who don't trust their own investment expertise. (For more on asset allocation, see "Build Your Own Mutual Fund Portfolio" tool). 

That said, mutual funds aren't necessarily low-cost investments. Many of them charge one-time "load fees" to new purchasers that can exceed 5 percent of the investment, and all mutual funds take on average take 1.3 percent of assets a year for operating expenses, expressed as the "expense ratio." 

As a result, "index" funds (see below) have surged in popularity in recent years because, on average, they...