What is a Mutual Fund?
Mutual funds give people a way to invest in a diverse mix of stocks, bonds, or other securities by buying shares of a larger pool that’s managed by a professional.
Mutual Funds are professionally managed pools that allow people to easily invest in a mishmash of securities, like stocks and bonds. Most of the time, they’re focused on stocks (aka, equities), but they can also come in different flavors, with a focus on bonds, foreign equities, or even risk levels. They’re managed by professional investors, who decide where to invest the pool, and they’ve become a popular destination in company-sponsored retirement plans, where workers place their hard-earned dollars. But their convenience isn’t free: Mutual funds come in different share classes with different fees and expenses. The potential risk and rewards of mutual funds are discussed in each fund’s prospectus.
Buying a share in a mutual fund is kind of like getting a scoop of fruit salad…
Everyone who owns a share in a mutual fund gets the same mix of investments, whether that’s stocks, bonds, or cash — every scoop has the same proportion of ingredients. As the value of the fund as a whole rises or falls in value, each person’s investment fluctuates with it.
Owning a share of a mutual fund is different from owning a single stock in six main ways:
A couple aspects of mutual funds are pretty appealing to many people:
In some ways, mutual funds operate much like a company. There’s someone managing the fund, known as a fund manager, or investment adviser, whose job is to make the best investment decisions on behalf of the pool’s shareholders. These fund managers might also hire analysts to help them research the market and make investment decisions.
These expenses mean that mutual funds almost always come at a cost to the investor, regardless of whether they put a huge or small amount into the pool. This cost is often a fee charged on an ongoing basis that takes a percentage of how much you’ve invested in the fund. If a mutual fund has a 0.5% fee, called an expense ratio, the shareholder pays $5 per year for every $1,000 invested. Typically the fund doesn’t send a bill in the mail — they’ll deduct it from the assets of the fund. These expense ratios can typically range anywhere from less than 0.1% to more than 3%.
Class A shares: But, not every share within a fund comes with the same type and amount of fees. Funds can be made up of many different groups of shares, known as “classes,” which have different fee structures. Class A shares, for example, typically charge a sales fee from the get go, that gets deducted from your initial investment. However, they tend to have a lower yearly expense ratio than our next group, Class B. Class A shares might also have a 12b-1 fee (an annual fee that covers the costs of marketing and selling fund shares), although this fee would generally be lower than the 12b-1 fee for certain other classes.
Class B shares: Class B shares tend not to have an upfront fee, but do usually trigger a fee when you sell your shares in the fund a certain number of years after purchasing those shares. This is called a back-end or deferred sales charge, and often applies if an investor sells their shares within five to eight years. Fund managers also don’t typically adjust those costs even if you buy a lot of shares. As a result, this group can be appealing to investors who may not have a lot of cash to invest right now, but who plan to keep their money invested for a long time. Over time, Class B shares can be converted to Class A shares, but until that happens, you’re like to have higher yearly fees associated with owning Class B’s.
Class C shares: Meanwhile, Class C shares might have a 12b-1 fee and a deferred sales charge or upfront fee, but the deferred sales charge or upfront fee is usually lower than Class B’s deferred sales charge or Class A’s upfront fee. Class C can have some advantages for people who might not be investing in a fund for a long period of time. These shares usually only charge additional sales fees for selling shares if investors withdraw from the pool within the first year.
The Prospectus: It’s important to know how much funds charge in fees when deciding whether or not to invest. Keep in mind, managers typically charge a fee even if the fund loses money. More information about a fund’s fees and expenses can be found in a legal document called a “prospectus.” You can get a fund’s prospectus by contacting the mutual fund or the financial professional selling the fund. Read the prospectus carefully before investing -- it’s packed with critical info in what you’re about to put your money into.
Investors in mutual funds can receive their money back by redeeming their shares from the fund. The fund itself that invests the money earns a return in two primary ways as the underlying investments rise in value or fall, increasing or decreasing the price of the fund’s shares:
Mutual funds come with a lot of perks, but they have their limitations and downsides. Here are some key ones:
Mutual funds are often focused on stocks, but there are plenty of other varieties. There are mutual funds for almost every type of investment, whether that’s bonds, foreign equities, or investments focused on specific slices of the mark, or risk levels. Funds can also be built around what’s known as the “target date” -- the time by which the investors in the pool are planning to retire, and access any gains from the pool.
Funds fall into two primary categories, that explain when and where people can buy or sell their shares:
Despite the variety that’s out there, many mutual funds tend to have one thing in common: diversification. The average fund holds hundreds of securities with the goal of giving investors exposure to a variety of different investments .
Like mutual funds, ETFs are made up of a smoothie-like mix of securities, which can help an investor manage their overall risk. However, these types of investments have two major differences:
Robinhood Financial LLC does not offer mutual funds. For more information about mutual funds and ETFs, see the SEC’s Guide for Investors. 20190617-875554-2639814