What is a mutual fund?
Discover the intricacies of mutual fund investment and explore their pricing mechanisms, varieties, management styles, and the pros and cons of adding them to your portfolio.
Summary
A mutual fund invests your money in a diversified portfolio of stocks, bonds, or other securities.
There are various types of mutual fund options according to your risk appetite, investment goal, and time horizon.
Mutual funds can be actively or passively managed.
There are distinct differences between a mutual fund and an exchange-traded fund (ETF).
How are mutual funds priced?
The value of a mutual fund is directly tied to the performance of the underlying assets in its portfolio.
As the securities within the fund fluctuate in the market, so does the net asset value (NAV) of the mutual fund itself. The NAV is calculated by dividing the total value of the fund's assets by the number of outstanding shares.
What are the different types of mutual funds?
There are a range of options to bear in mind when considering investing in a mutual fund. Different types of mutual funds may cover anything from broad indexes to specific sectors, so it is essential that you select a fund type that best caters to your risk appetite, investment goal, and time horizon.
Here is a breakdown of the main fund types available to you:
Stock funds
Stock funds, also known as equity funds, invest in a portfolio of individual stocks and offer the potential for high returns. However, the inherent volatility of stock prices also means that these funds come with a commensurate level of risk. Stock funds are best suited to you if you have a higher risk tolerance and a longer investment time horizon.
Index funds
Index funds track a specific market index, such as the S&P 500, the Dow Jones Industrial Average or the Nasdaq Composite. These funds replicate the performance of the chosen index and provide broad market exposure with lower management fees. An index fund will suit you if you are looking for a cost-effective investment strategy with lower risk.
Bond funds
Also known as a debt fund, bond funds invest in a diversified portfolio of bonds or other debt securities. Bond funds are generally less risky than stock funds, making them attractive to investors who seek income and capital preservation. If yours is a more conservative risk profile and you prefer a steady income, then a bond fund might suit your needs.
Balanced funds
As the name suggests, balanced funds strike a balance between stocks and bonds. They aim to blend capital appreciation and income while mitigating overall portfolio risk. If you are looking for a middle-ground approach that combines the growth potential of stocks with the stability of bonds, then a balanced fund may meet your investment criteria.
Target-date funds
Target-date funds are designed for investors with a specific retirement date in mind. These funds automatically adjust their asset allocation over time and become more conservative as the target date approaches. If you are planning for retirement, then a target-date fund is a convenient hands-off approach that adjusts your risk exposure as your financial goal approaches.
It is essential to understand the different types of mutual funds and how they are managed before investing. A financial advisor will provide you with valuable insights into mutual funds that are appropriate to your unique situation. By answering just a few questions, we'll connect you to an SEC-regulated financial advisor perfectly suited to your needs. Get matched with an advisor here.
What are the different ways in which funds are managed?
Once you've identified the type of mutual fund that aligns with your investment objectives, the next consideration is how the fund is managed. There are two main management styles: active and passive.
Actively managed
Actively managed funds have fund managers who make strategic decisions to buy or sell securities by closely monitoring market trends, economic indicators, and individual securities. This can lead to outperformance during favorable market conditions, but active management also involves higher fees.
Passively managed
Passively managed funds aim to mirror the performance of a particular market index rather than trying to beat the market. These funds are typically associated with lower management fees, making them an attractive option for cost-conscious investors.
What are the pros and cons of investing in a mutual fund?
Pros:
By offering a diversified spread of investments across a variety of assets, mutual funds reduce the impact of poor performance from a single security.
Professional fund managers bring expertise and market knowledge to optimize the fund's performance.
Mutual funds are accessible to investors with various risk tolerances and financial goals.
Mutual funds offer an affordable entry point due to lower minimum investment amounts.
Cons:
Most mutual funds carry management fees and other expenses, which can eat into your returns.
The value of mutual funds is subject to market fluctuations, and there is no guarantee of profits.
Investors may unknowingly hold similar securities across multiple funds, thereby reducing the benefits of diversification.
Investors delegate decision-making to fund managers and have no direct control over investment choices.
What is the difference between a mutual fund and an exchange-traded fund (ETF)?
While mutual funds and exchange-traded funds (ETFs) are both investment vehicles, there are distinct differences that may influence your investment strategy. Here are some key comparisons:
Mutual funds are bought and sold through the fund company at the end of the trading day at the net asset value (NAV). ETFs are traded on stock exchanges throughout the day, with prices fluctuating based on market demand.
Mutual funds usually have minimum investment requirements. ETFs can be purchased in increments of a single share.
Mutual funds can be actively or passively managed. ETFs are typically passively managed, tracking specific indexes.
The bottom line
From pricing mechanisms based on underlying securities to the diverse array of fund types that cater to various needs, mutual funds offer a versatile avenue for wealth creation. You can opt for actively managed funds that provide the expertise of fund managers or the cost-efficient simplicity of passively managed funds.
As with all investment instruments, there are pros and cons to investing in mutual funds. A financial advisor you can trust will help you negotiate the nuances of investing in mutual funds that align with your financial goals, risk tolerance, and investment horizon. Let Unbiased match you with a trustworthy financial advisor to find the advice you need to successfully manage your investments and maximize the advantages of mutual funds.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.