- A common type of investment company, mutual funds are open-end funds, meaning that investors can purchase and redeem shares in the funds on a daily basis based on the net asset value (NAV) of their shares.
- Mutual funds pool the money of many investors to purchase a range of securities to meet specified objectives, such as growth, income or both.
- Mutual funds can offer cost-effective diversification.
- Each mutual fund has a different investment objective. Some funds invest in a particular product, such as stocks or bonds. Some focus on a particular industry or region. Others seek to replicate a market index.
- All mutual funds have fees and expenses. Use FINRA’s Fund Analyzer to analyze and compare the costs of owning specific funds.
- A mutual fund may have different share classes with different costs. Your investment professional might receive higher (or lower) commissions or payments for the sale of one share class relative to another.
- It’s important to read a mutual fund’s prospectus to learn about its objectives, investments, strategies and costs.
Mutual funds are a popular way to invest in securities. Because mutual funds can offer built-in diversification and professional management, they offer certain advantages over purchasing individual stocks and bonds. But, like investing in any security, investing in a mutual fund involves certain risks, including the possibility that you might lose money.
A mutual fund is a type of investment company, known as an open-end fund, that pools money from many investors and invests it based on specific investment goals. The mutual fund raises money by selling its own shares to investors. The money is used to purchase a portfolio of stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. Each share represents an ownership slice of the fund and gives the investor a proportional right, based on the number of shares they own, to income and capital gains that the fund generates from its investments.
The particular investments a fund makes are determined by its objectives and, in the case of an actively managed fund, by the investment style and skill of the fund's professional manager or managers. The holdings of the mutual fund are known as its underlying investments, and the performance of those investments, minus fund fees, determine the fund's investment return.
All of the details about a mutual fund—including its investment strategy, risk profile, performance history, management and fees—are provided in its prospectus. You should always read the prospectus before investing in a fund.
How They Work
Mutual funds are equity investments, as individual stocks are. When you buy shares of a fund, you become a part owner of the fund, and you share in its profits. For example, when the fund's underlying stocks or bonds pay income from dividends or interest, the fund pays those profits, after expenses, to its shareholders in payments known as income distributions. Also, when the fund has capital gains from selling investments in its portfolio at a profit, it passes on those after-expense profits to shareholders as capital gains distributions. You generally have the option of receiving these distributions in cash or having them automatically reinvested in the fund to increase the number of shares you own.
All mutual funds have fees, with some charged at specific times, based on actions you take, and some are charged on an ongoing basis. Each fund's prospectus describes its fees in detail. You can also analyze and compare the costs of owning funds by using FINRA’s Fund Analyzer.
Mutual funds are registered with the Securities Exchange Commission (SEC) and are subject to SEC regulation.
Learn how mutual funds compare to exchange-traded funds.
Understanding Investment Companies
Investment companies can be structured as either open-end or closed-end funds—although most investment companies are open-end funds, known more commonly as mutual funds. One of the key distinguishing features of a mutual fund is that investors can buy and sell shares at any time. The fund will create new shares to meet increased demand and buy back shares from investors who want to sell. Sometimes, mutual funds get so large that they close to new investors. Even if a mutual fund is closed, however, it still remains an open-end fund since existing shareholders can continue to buy and sell fund shares.
Mutual funds calculate the value of one share, known as the net asset value (NAV), only once a day, when the investment markets close. All purchases and sales for the day are recorded at that NAV. To figure its NAV, a fund adds up the total value of its investment holdings, subtracts the fund's fees and expenses, and divides that amount by the number of shares that investors are currently holding.
Unlike stock prices, NAV isn't necessarily a measure of a fund's success. Since mutual funds can issue new shares and buy back old ones all the time, the number of shares and the dollars invested in the fund are constantly changing. That's why it makes more sense to compare mutual funds by looking at their total return over time rather than comparing their NAVs. But always remember that past returns don’t necessarily predict future returns.
Closed-end funds, which are a less common type of investment company, differ from open-end funds because they raise money only once in a single offering, much the way a company might raise money at its initial public offering (IPO). After the shares are sold, the closed-end fund uses the money to buy a portfolio of underlying investments, and any further growth in the size of the fund depends on the return on its investments, not new investment dollars. The fund is then listed on an exchange, the way an individual stock is, and shares trade throughout the day.
The price for closed-end funds rises and falls in response to investor demand and may be higher or lower than its NAV or the actual per-share value of the fund's underlying investments.
A third type of investment company, the unit investment trust (UIT), has characteristics of both mutual funds and closed-end funds. A UIT invests the money raised from many investors during its one-time public offering in a generally fixed portfolio of stocks, bonds or other securities. Unlike either mutual funds or closed-end funds, though, UITs have a preset termination date, at which time any remaining investment portfolio securities are sold, with the proceeds paid to the investors.