Master the basics of mutual funds

With a single investment, you can put your money in hundreds of different stocks or bonds, making diversification a snap. If you invest in a retirement account, you may already own a mutual fund. Learn how they work and how to make the most of them.

A sum greater than its parts

Who can afford to invest in hundreds of different companies? When you buy a share of a mutual fund, you pool your money with thousands of other investors. So it’s more affordable to spread your money over many investment opportunities.

Managed with a mission

There are thousands of mutual funds to choose from. Every fund starts with a mission or investment goal. Some focus on the stocks of large U.S. companies, for example, while others might search for opportunities in international bonds. For almost any type of investment you can think of, there’s probably a mutual fund that invests in it.

When a fund is actively managed, each investment is carefully chosen and monitored by professional managers whose careers are devoted to researching investments and market trends. They can buy or sell investments depending on market conditions.

Index funds, on the other hand, reflect the same investments as the financial market they represent. When the market’s up, the fund goes up with it, but when the market’s down, the fund falls just as far.

Peek inside a mutual fund

A mutual fund could include many types of investments, or asset classes. Here are the three most common:

• Stock funds invest in company stocks, also known as equities. Stocks typically carry a greater amount of risk than bonds, since share values go up and down with a company’s profits and losses. 

   

• Bond funds hold more stable investments like Treasury bonds, municipal bonds or corporate bonds. These are called “fixed income” investments, and they are generally less risky than stocks. But they’re also less likely to grow as much.

   

• Money market funds invest in very short-term bonds and cash-like investments. These may be the least risky, but their investors don’t expect big returns.

   

These are the broadest categories. There are also funds that invest in a combination of stocks, bonds or cash to provide a level of diversification. Some even invest in other mutual funds. These “funds of funds” go by names like asset allocation funds or target date funds. You may be familiar with target date funds because they are often the default option in an employer’s retirement plan. In that case, they're designed to adjust the mix of investments as you move closer to the date you plan to retire.

Why you might already own a fund

More than 115 million people — 52% of U.S. households — own mutual funds.^* Why are they so popular?

• Simple — It’s easy to buy shares in a mutual fund, and a single share enables you to hold multiple investments.

   

• Affordable — The minimum required investment can be low — sometimes just a couple hundred dollars — and you can continue to make small automatic investments. You can do that easily in a 401(k) plan at work.

   

• Diversification — When you buy shares in a mutual fund, you put your money in a wide variety of investments. Owning a diverse mix of investments can help lower risk. When one company, industry or investment does badly, others could make up for that loss.

   

• Professional oversight — Most people don’t have the time or knowledge required to choose and constantly manage multiple investments. Mutual fund managers dedicate their careers to watching the markets and researching companies. They select and monitor the investments in a mutual fund for you.

Finding the right mix

A single mutual fund provides a certain level of diversification. A stock fund, for instance, can be invested in many companies. But it’s still just one asset class (stocks). True diversification means having different types of investments to match your needs. A balanced portfolio can have a little bit of everything — large and small companies, domestic and international markets, corporate and municipal bonds … You get the picture. A financial professional can help you decide on the mix that’s right for you.