What are Mutual Funds and How Do They Work?

Mutual fund investment is a popular solution for those looking to save for later life. This is often used by people to build retirement funds, either via 401(k)s or as individual investments. What are mutual funds and how does fund investment work?

What are Mutual Funds?

A mutual fund works by taking cash from a pool of people and investing it as a whole rather than on an individual basis. The aim here is to leverage greater buying and diversification power by building higher levels of investment, even if the money available to investors represents small sums.

How Does Mutual Fund Investment Work?

In some cases, investors will need to buy into funds via a broker; in others the fund company will allow direct investment. Those looking to use 401(k) cash may be given a range of options to choose from. General investments may not be limited in this way, although some companies impose minimum cash limits.

Funds can generally be accessed at any time, although selling early may incur charges and reduce potential returns. An investment can be measured by rises in market value, dividends and capital gains distributions or a mix of the three.

What Do Mutual Funds Invest In?

Common investments include stocks, bonds, securities, assets and cash. Some companies may have a focused portfolio and may, for example, only invest in specific sectors or indices. Others may invest more generally to spread risk. Some funds are designed for the long-term while others may be targeted at quicker returns.

What are the Advantages and Disadvantages of Investing in Mutual Funds?

A mutual fund allows an individual to invest relatively small sums of cash with higher potential returns due to the pooling of capital. This gives greater diversification than can often be achieved by standard stock market investment. Those using funds also don’t have to worry about how to invest as the fund will be managed for them.

There are no guarantees of returns with these funds, however, and choosing the wrong type or an ineffective manager may not give the desired results. Mutual funds are also not guaranteed by the FDIC and fees and charges can eat into the overall return.

How Much Does Mutual Fund Investment Cost?

Investing in a mutual fund will incur some costs. Some companies will charge fees when individuals buy into funds and/or sell their holdings unless they are offering no load options. Management or operating fees will, however, be charged as standard. Those using a broker will also have to factor in their charges.

How to Choose the Best Mutual Fund

Those considering using mutual funds to save for the future may find it useful to consider the pros and cons of this kind of investment in more detail. Online calculators and research can help to compare costs and to assess potential performance, making it easier to find the right fund to suit individual needs.