What is a mutual fund?

E*TRADE from Morgan Stanley, in collaboration with Capital Group, home of American Funds®


Mutual funds are a common type of investment found in the portfolios of many investors. In fact, if you have a retirement account such as a 401(k), you may already own a mutual fund. They are a simple way to diversify your portfolio and potentially benefit from professional management.

Before we dig into the details, let’s get clear on what a mutual fund actually is. A mutual fund pools together money from many investors and uses it to buy a mix of individual investments such as stocks or bonds. A professional money manager decides which investments the mutual fund will buy or sell, how much of each to buy or sell, and when to make trades—all based on the investment objective of the fund, which is described in its prospectus. The money manager earns a fee, paid out of the fund's assets. for these services.

Shares in mutual funds are valued once a day and are bought or sold at that price, typically after the market closes.

Types of mutual funds

Mutual funds come in many varieties. Some buy only stocks, some buy only bonds, and others buy both. Many funds are targeted at specific industry sectors, like retail or health care, while others might invest only in large companies or focus on an investment objective like growth. Still others aim to track a market index. In short, there are funds to match nearly every investment strategy or approach.

No matter what types of mutual funds you might be looking at, it’s important to keep in mind that each type comes with certain risks that every potential buyer should carefully consider, and these are also described in the prospectus. The prospectus also contains each fund's expenses and fees.

Investors use mutual funds for several reasons:

  1. Diversification. Because mutual funds buy dozens or even hundreds of different securities, they are inherently diversified, potentially lowering your risk.
  2. Simplicity. Buying a share in a single fund is much easier than researching and buying dozens of individual stocks and bonds.
  3. Professional oversight. The fund’s manager does the work of choosing and monitoring investments, so you don’t have to.

Fees and expenses

It’s also important to know that mutual funds charge fees to their investors, including investment advisory, distribution, and administrative and shareholder service fees. Ongoing fees are shown in what’s known as the fund’s expense ratio, which is a percentage of the fund’s assets, which can be less than 1%.* These fees are regularly deducted from the fund’s total value, which reduces the return for investors who own shares in the fund.

Some mutual funds also charge a sales fee, called a load, when you buy or sell your shares, and most require you to make a minimum investment, which may be as little as a few hundred dollars. Many mutual funds offer different classes of shares, such as Class A or Class B shares. Each class represents an investment in the same portfolio, but they may charge different fees and expenses at different times—when you buy shares (Class A) or when you sell them (Class B), for example.

Of course, there’s much more to learn about mutual funds. Mutual funds are a simple, diversified way to invest, which makes them a key component in the long-term portfolios of many investors.

*According to the ICI Research Perspective for March 2020 (Vol. 26, No.1) average expense ratios in 2019 were as follows:

  • Equity mutual funds: 0.52%
  • Bond mutual funds: 0.48%
  • Hybrid mutual funds: 0.62%
  • Target date mutual funds: 0.37%
  • Active-managed equity funds: 0.74%
  • Index equity funds: 0.07%

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