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What Is A Mutual Fund?

Mutual funds are the backbone of many American's retirement account investments, but many investors aren't really sure what they are, or how they work. Simply put, a mutual fund is a company that pools money from many investors and invests those funds into different securities like stocks and bonds which are selected based on the objectives and goals of that fund. Each mutual fund company will typically have multiple funds for investors to choose from with different goals for each fund. For example, a "growth" mutual fund will invest with the goal of growing the value of the assets over a long term, for perhaps a retirement account. An "income" fund on the other hand will have a goal of providing an income to its investors and may be favorable for individuals that have already retired and are looking to turn their investments into income in retirement. Below are some frequently asked questions about mutual funds, and more information.

"How does a mutual fund grow my investment?"

- Mutual funds grow in three ways

  1. Increase to NAV (Net Asset Value) - NAV is the value of each share of a mutual fund. For example, let's say you invest $10,000 into a mutual fund, and each share's NAV is $10.00. If the underlying investments in the fund were to grow and the NAV were to increase to $11.00, then the investor's growth would be 10%, or $1,000.00.
  2. Dividends - Dividends are an income that are paid from inside of a stock or bond like an interest rate paid to the investor. If an investor were to purchase 100 shares of stock in a company that paid an annual dividend of $1.00, then the investor could earn $100 in dividend income each year. Mutual funds that invest in stocks and bonds that pay dividend or interest to the shareholders will receive that income.
  3. Capital gains distribution - Capital gain is when we see an investor sell a security for more than they paid for it. The difference between the purchase price and sales price is considered a capital gain. When a mutual fund sells shares of a security it has held for more than it paid for that security that capital gain appreciation will reflect positively on the NAV of the fund.

"Do mutual funds have risk?"

Yes. All mutual funds assume some degree of risk. The amount of risk taken will depend on the fund chosen, and the goals of that fund. Choosing a mutual fund that fits your risk tolerance and goals is very important. If you aren't sure which mutual funds are right for you, you should consult with your financial professional for advice.

"What are the benefits of mutual funds?"

Mutual funds have many benefits, but some of the highlights are as follows:

  1. Mutual funds are run by professionals who will often have much more experience and expertise than the average investor, and the fund managers monitor the performance of the fund and make changes as necessary. This can save the investor lots of time and stress in choosing the underlying investments, and provide some peace of mind for investors who are unsure of how to invest to meet their investment objectives.
  2. Liquidity is another great benefit of mutual funds. Mutual funds allow the investor to sell their shares of the fund at any time, subject to any applicable redemption fees. This is a great benefit for investors who want to be able to invest money without being stuck in a contract.
  3. Mutual funds also allow investors to diversify their investment portfolios without complication. An investor can choose from different fund families and in funds with different objectives to allow for a broader range of investments across their investment portfolio.

"How do mutual fund fees work?"

Mutual funds charge fees to cover the operating costs of the fund. For example, the salary of the fund manager, and all other employees, marketing and advertising materials, and other administrative expenses are incurred by the fund. The fund will charge a fee to the investor to cover these costs. These fees can vary greatly, and are an important element to consider before purchasing a mutual fund. You should consult with your financial professional about the fees and expenses of the mutual fund you are considering before purchasing. 

If you have more questions about mutual funds, we would like to hear from you. Send us a question, or schedule an appointment directly with us and we will have a registered financial professional reach out to help.

What are mutual funds -investor.gov

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