A mutual fund is a fund that pools money from a group of investors to buy financial securities such as bonds and stocks to minimise costs, diversify investment risks, and maximise returns. Investors in funds don’t directly own the securities in the fund but hold shares in the fund.
Understanding Mutual Funds
Mutual funds pool money from the investing public and use that money to buy other securities, usually stocks and bonds. The value of the mutual fund company depends on the performance of the securities it decides to buy. So, when you buy a unit or share of a mutual fund, you are buying the performance of its portfolio or, more precisely, a part of the portfolio’s value. Investing in a share of a mutual fund is different from investing in shares of stock. Unlike stock, mutual fund shares do not give their holders any voting rights. A share of a mutual fund represents investments in many different stocks (or other securities) instead of just one holding.
How Mutual Funds Work
- Income is earned from dividends on stocks and interest on bonds held in the fund’s portfolio. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution. Funds often give investors a choice either to receive a check for distributions or to reinvest the earnings and get more shares.
- If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
- If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit in the market.
Mutual funds can also classify as growth-oriented or income-oriented funds, in addition, to actively managed or index funds. Growth-oriented funds seek the growth of capital, while income funds seek to produce a steady income stream with dividends.
In actively managed funds, fund managers can buy and sell investments within the fund’s portfolio. With index funds, the composition of the fund fixes to an established portfolio that doesn’t change over time, typically tracking an index for a particular asset group.