Back to Basics: What’s a Mutual Fund?

Investing in the vast world of the financial markets can be challenging. You’re looking at a multitude of different markets and products, all of which require time to analyze and possibly loads of capital to accumulate. But there are also simpler and more efficient solutions available, including mutual fund investments. Buying shares of a mutual fund can provide you with fractional ownership in a wide and diversified range of markets and products.

Let’s explore this financial instrument. What is a mutual fund? How do they work? What potential benefits and risks do they present? Finally, we’ll touch on the different varieties and cover how you might go about finding the right funds to match your investment goals.

Carefully consider the investment objectives, risks, charges and expenses before investing in a mutual fund. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.

Mutual Fund Definition

What is a mutual fund, exactly? It’s a collective investment that pools together money from a large number of investors in order to purchase a variety of securities such as stocks or bonds. Think of it as a basket of investments typically consisting of stocks (company shares), bonds (debt issued by corporations or governments), or both. When you buy a share, you own a fractional stake in all of the investments in the basket.

Potential Benefits of Mutual Fund Investing

One of the main benefits of a mutual fund investment is diversification. Think of a fund as a ready-made portfolio composed of numerous investments. A mutual fund can spread out both your market exposure and your risk by avoiding over-concentration in any one area of the market. In other words, if a given stock or bond performs poorly, its overall impact on the entire fund may be small, especially if the other securities within it perform better.

Another benefit of investing in mutual funds is that they allow you to participate in a wide variety of investment types. This may be useful for investors who lack the time to analyze a multitude of stocks and bonds or lack the capital to purchase sizable shares in multiple assets. By purchasing shares of a mutual fund, you may gain exposure to a wide range of markets and asset classes more efficiently than by doing it all yourself.

Finally, mutual funds are managed by professionals who are paid to identify market opportunities and risks. Managers also occasionally rebalance assets to keep the funds on track toward achieving their investment objectives.

How Does a Mutual Fund Investment Gain or Lose Value?

Successful mutual funds create returns via appreciation or income. Appreciation refers to an increase in value; income comes from dividend or interest payments. Some funds focus on one or the other, while others provide an assortment of both.

By holding shares of a mutual fund, you own a small stake in each security held by the fund. This also means the value of your shares rises and falls along with the gains and losses of each security in the basket. Whether you seek returns through appreciation or income, your exposure to potential loss is always a risk.

Other Mutual Fund Risks

It goes without saying that not all mutual funds will perform well. Some funds outperform others at times. Because you can’t predict how it might perform over the long term, selecting a mutual fund based on past performance may not be the best way to go about it. You should be comfortable with a fund’s overall performance, but also make sure its investment objectives align with your financial goals.

Another thing to be aware of is that mutual fund values are calculated at the end of the trading day, meaning you can’t buy or sell them intraday. Does that matter? Suppose the stock market experiences a major decline and you want to sell your shares in the middle of the trading day. You won’t be able to exit your position until after the market closes.

Another thing to consider is the impact of costs and fees on the value of your shares. You’re likely to pay management fees (regardless of whether a fund performs well), transaction costs, sales loads, and other expenses that may reduce your total returns.

Finding the Right Mutual Funds

Mutual funds come in a wide variety of products and allocations. Depending on what you’re looking to achieve financially, there’s likely a category of funds to match your goals.

Generally, you have a choice of equity funds that focus on stocks, fixed-income funds that focus on bonds, and balanced funds that hold both stocks and bonds. Some mutual funds invest in whole indices (such as the S&P 500), while others focus on specific market sectors such as Technology, Financials, and Utilities. There are also mutual funds that invest in different countries.

Mutual funds have various investment objectives, too. Some funds seek “growth,” which usually means they invest in companies that tend to have growing sales, revenues, earnings per share, and stock prices that are trending up. Other funds seek “value,” meaning they invest in companies that may be undervalued relative to their fundamentals and that may have suffered recent price declines.

Each mutual fund comes with a prospectus, which is a summary and explanation of how the fund operates. The prospectus discloses fees, charges, performance history, the minimum investment amount, risks, and other important information.

Once you’ve identified a mutual fund that might be right for you, be sure to read its prospectus. The prospectus details should help you determine if it matches your investment goals.

Tools to Analyze and Select Mutual Funds

There are plenty of online tools and resources that might help you better understand and select mutual funds. You can always check out the TD Ameritrade mutual funds tools and resources page or try the mutual funds screener. For more extensive learning materials, visit the TD Ameritrade Education page.

There’s a lot to learn about mutual funds as well as the many other investing tools at your disposal. And whenever you’re ready, we’ve got the resources to help you get started. You can also check out this quick mutual funds basic video tutorial.