What is a mutual fund?

Mutual funds have been around for over a century and have gained popularity with investors since the 1980s. There are many to choose from, each potentially offering convenient, cost-effective ways to diversify your portfolio with professional management. If you have a retirement account, such as a 401(k), then chances are you already own a mutual fund. Here’s how mutual funds work.  

A mutual fund pools money from multiple investors and uses those funds to purchase a portfolio that may include stocks, bonds, or other assets. The same investors can then purchase shares of the fund, providing them each partial ownership of the portfolio.

The mutual fund is managed by a professional fund manager who selects the underlying investments that the fund buys or sells. The fund manager also determines the quantity and timing of the fund’s trades. Investment decisions are based on specific market strategies determined by the investment objective of the fund, which you can find in the fund’s prospectus.

Mutual funds can be used to diversify an investment portfolio. Diversification and professional oversight can help build a well-rounded portfolio and mitigate individual security risk. Before making an investment decision, always review a fund’s risks, costs, and objectives in the fund’s prospectus.

Mutual funds come in many varieties.  Some mutual funds may be actively managed, where the fund manager makes decisions based on an investment thesis and security analysis. Alternatively, other funds may be passively managed, also known as index funds, which are designed to track a specific market index (e.g., the S&P 500 or Nasdaq 100) with the goal of generating benchmark-like returns.

In general, actively managed funds tend to have higher expense ratios than index funds.

The most common types of mutual funds are:

1. Equity funds, also known as stock funds, which invest in a company’s stock and can often carry greater risk since they are sensitive to market volatility.
2. Bond funds, which hold “fixed income” instruments, such as Treasury bonds, municipal bonds, or corporate bonds, are generally less volatile than stocks or equity funds.
3. Money market funds, which invest in short-term bonds and cash-like investments.
4. Target-date funds, which are primarily designed for retirement savings. These mutual funds adjust the asset allocation over a specific period of time, becoming more conservative as the investor’s retirement or target-date nears.

If you’d like to invest in a mix of stocks, bonds, and cash or cash equivalents, you may consider a balanced fund.

Mutual funds charge fees to cover the operational costs of managing the fund. Ongoing fees are shown in what is known as the fund’s (annual) expense ratio, stated as a percentage of the fund’s assets.

Fees may include:

• Investment advisory: the fund manager’s fee for their services and expertise.
• Distribution: the fee for marketing and selling fund shares.
• Administrative: costs associated with managing the fund such as legal, accounting, and compliance fees.
• Shareholder service: charges related to buying, selling, or other related transactions in the mutual fund.
• Load fees: Some mutual funds charge a sales fee, called a “load,” when you buy or sell your shares.
• Revenue-sharing: Also known as a mutual fund support fee, this fee is charged on client account holdings in fund families generally according to a tiered rate, which increases with the management fee of the fund. Revenue-sharing payments are generally paid out of the fund’s investment adviser, distributor, or other fund affiliate’s revenues or profits and not from the fund’s assets.

Mutual funds and ETFs are both pooled investments that can offer exposure to a variety of asset classes. However, there are several notable differences:

Regardless of the type of mutual fund you may be considering, it is important to review the risks, expenses, and objectives detailed in the fund’s prospectus.

CRC # 3815827 04/2025