Mutual funds

A mutual fund is a financial vehicle in which shareholders put their money together to invest in securities (e.g., stocks, bonds, money market instruments). A fund manager chooses the best investments, and every investor shares in the profits if the investments do well.

Mutual funds are an affordable way to help diversify your portfolio.

https://www.investopedia.com/terms/m/mutualfund.asp

What is a mutual fund?

Mutual funds let you pool your money with other investors to “mutually” buy stocks, bonds, and other investments.

1. They’re run by professional money managers who decide which securities to buy (stocks, bonds, etc.) and when to sell them.
2. You get exposure to all the investments in the fund and any income they generate.
3. They offer a wide variety of investment strategies and styles.
4. A mutual fund is a portfolio of stocks, bonds, or other securities purchased with the pooled capital of investors.
5. Mutual funds give individual investors access to diversified, professionally managed portfolios.
6. Mutual funds are known by the kinds of securities they invest in, their investment objectives, and the type of returns they seek.
7. Mutual funds charge annual fees, expense ratios, or commissions, which lower their overall returns.
8. Many American workers put their retirement funds into mutual funds through employer-sponsored retirement plans.

These funds hold much of the retirement funds of middle-income Americans, but this wasn’t always the case. In 1980, under 6% of U.S. households had money in mutual funds. By 2023, about 52% of American households were invested in them, and these households held shares for a vast majority, 88%, of all mutual fund assets. When setting aside their money in mutual funds, these households can access a broad range of investments, which can help cut their risk compared to investing in a single stock or bond. Investors earn returns based on the fund’s performance minus any fees or expenses charged. Mutual funds are often the investment vehicle of choice for middle America, providing a broad swath of middle-income workers with professionally managed portfolios of equities, bonds, and other asset classes. Investment Company Institute. “Majority of American Households Rely on Mutual Funds.”

Why invest in mutual funds?

Diversification

Mutual funds let you access a wide mix of asset classes, including domestic and international stocks, bonds, and commodities.

Low costs

Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are typically lower than what you would pay as an individual investor.

Convenience

Buying mutual funds can be straightforward. Many banks and brokerage firms, including Schwab, have their own line of proprietary mutual funds as well as access to thousands of third-party funds.

Professional management

You get the benefit of having a professional manager reviewing and researching the fund’s portfolio on an ongoing basis.

What is the difference between active and index mutual funds?

Actively managed funds

These funds typically strive to beat the market. They’re overseen by portfolio managers who select securities they think will outperform benchmarks. As such, actively managed funds are usually more expensive.

Index funds

These funds, known as index funds, are designed to track—rather than beat—a specific index, such as the S&P 500. They can be a low-cost way to invest.

Index vs. Active Mutual Funds

Attribute	Index Funds	Active Funds
Goal	Match a market index	Outperform the market
Management Style	Passive, automated	Active by fund managers
Fees	Low expense ratios	Higher expense ratios
Performance	Average market returns	Attempt to beat averages

What fees and costs are associated with mutual funds?

Investing costs can be a key factor in your net return. It’s important to understand how mutual funds assess fees and expenses. These fall into three broad categories:

Operating expense ratio (OER)

OERs cover the fund’s operating expenses and are annually factored into the total return you receive.

Sales charges or loads

A load is a one-time commission some fund companies charge whenever you buy or sell shares in certain load-based mutual funds.

Transaction fee

Brokerage firms may charge a trading fee whenever you buy or sell mutual fund shares.

How Are Earnings Calculated for Mutual Funds?

When researching the returns of a mutual fund, you’ll typically come upon a figure for the “total return,” or the net change in value (either up or down) over a specific period. This includes any interest, dividends, or capital gains the fund has generated along with the change in its market value during a given period. In most cases, total returns are given for one, five, and 10-year periods, as well as from the day the fund opened or inception date.

Investors typically earn returns from a mutual fund in three ways:

Dividend/interest income

Mutual funds distribute the dividends on stocks and interest on bonds held in its portfolio. Funds often give investors the choice of either receiving a check for distributions or reinvesting earnings for additional shares in the mutual fund.

Portfolio distributions

If the fund sells securities that have increased in price, the fund realizes a capital gain, which most funds also pass on to investors in a distribution.

Capital gains

When the fund’s shares increase in price, you can sell your mutual fund shares for a profit in the market.

What types of mutual funds are there?

Common mutual funds

These funds aim to meet the fund’s objectives by investing in traditional assets (equities, fixed income, and/or cash) using traditional strategies (fundamental relative value, indexing, etc.). A large majority of funds fall into this category.

Specialty mutual funds

These funds aim to meet the fund’s objectives through non-traditional investments and trading strategies, such as investing in commodities, or making investments based on environmental or social governance guidelines.

Types

There are many types among the more than 7,000 mutual funds in the U.S., with most in four main categories: stock, money market, bond, and target-date funds.

Stock funds

As the name implies, this fund invests principally in equity or stocks. Within this group are assorted subcategories. Some equity funds are named for the size of the companies they invest in: firms with small-, mid-, or large-sized capitalization. Others are named by their investment approach: aggressive growth, income-oriented, and value. Equity funds are also categorized by whether they invest in U.S. stocks or foreign equities.

Value funds invest in stocks their managers see as undervalued while aiming at long-term appreciation when the market recognizes the stocks’ true worth. These companies are characterized by low price-to-earnings (P/E) ratios, low price-to-book ratios, and dividend yields. Meanwhile, growth funds look to companies with solid earnings, sales, and cash flow growth. These companies typically have high P/E ratios and do not pay dividends.7 A compromise between strict value and growth investment is a “blend.” These funds invest in a mix of growth and value stocks to give a risk-to-reward profile somewhere in the middle.

Large-cap companies have market capitalizations of over $10 billion. Market cap is derived by multiplying the share price by the number of shares outstanding. Large-cap stocks are typically for blue-chip firms whose names are recognizable. Small-cap stocks have a market cap between $250 million and $2 billion. These companies tend to be newer, riskier investments. Mid-cap stocks fill in the gap between small- and large-cap.8

A mutual fund may combine different investment styles and company sizes. For example, a large-cap value fund might include in its portfolio large-cap companies that are in strong financial shape but have recently seen their share prices fall; these would be placed in the upper left quadrant of the style box (large and value). The opposite of this would be a small-cap growth fund that invests in startup technology companies with high growth prospects. This kind of fund is in the bottom right quadrant above (small and growth).

Bond funds

A mutual fund that generates a consistent and minimum return is part of the fixed-income category. These mutual funds focus on investments that pay a set rate of return, such as government bonds, corporate bonds, and other debt instruments. The bonds should generate interest income that’s passed on to the shareholders.

There are also actively managed funds seeking relatively undervalued bonds to sell them at a profit. These mutual funds will likely pay higher returns but aren’t without risk. For example, a fund specializing in high-yield junk bonds is much riskier than a fund that invests in government securities.

Because there are many different types of bonds, bond funds can vary dramatically depending on when and when they invest, and all bond funds are subject to risks related to changes in interest rates.

Index mutual funds

Index mutual funds are designed to replicate the performance of a specific index, such as the S&P 500 or the DJIA. This strategy requires less research from analysts and advisors, so fewer expenses are passed on to investors through fees, and these funds are designed with cost-sensitive investors in mind.

They also frequently outperform actively managed mutual funds and thus potentially are the rare combination in life of less cost and better performance.

Balanced funds

Balanced funds invest across different securities, whether stocks, bonds, the money market, or alternative investments. The objective of these funds, known as an asset-allocation fund, is to cut risk through diversification.

Mutual funds detail their allocation strategies, so you know ahead of time what assets you’re indirectly investing in. Some funds follow a strategy for dynamic allocation percentages to meet diverse investor objectives. This may include responding to market conditions, business cycle changes, or the changing phases of the investor’s own life.

The portfolio manager is commonly given the freedom to switch the ratio of asset classes as needed to maintain the fund’s stated strategy.

Money market mutual funds

The money market consists of safe, risk-free, short-term debt instruments, mostly government Treasury bills. The returns on them aren’t substantial. A typical return is a little more than the amount earned in a regular checking or savings account and a little less than the average certificate of deposit (CD). Money market mutual funds are often used as a temporary holding place for cash that will be used for future investments or for an emergency fund. While low risk, they aren’t insured by the Federal Deposit Insurance Corporation (FDIC) like savings accounts or CDs.

Income funds

Income funds are meant to disburse income on a steady basis, and are often seen as the mutual funds for retirement investing. They invest primarily in government and high-quality corporate debt, holding these bonds until maturity to provide interest streams. While fund holdings may rise in value, the primary goal is to offer a steady cash flow​.

International mutual funds

An international mutual fund, or foreign fund, invests only in assets located outside an investor’s home country. Global funds, however, can invest anywhere worldwide. Their volatility depends on where and when the funds are invested. However, these funds can be part of a well-balanced, diversified portfolio since the returns from abroad may provide a ballast against lower returns at home.

Regional mutual funds

Often international in scope, regional mutual funds are investment vehicles that focus on a specific geographic region, such as a country, a continent, or a group of countries with similar economic characteristics. These funds invest in stocks, bonds, or other securities of companies that are headquartered, or generate a significant part of their revenue, within a targeted region.

Examples of regional mutual funds include Europe-focused mutual funds that invest in that continent’s securities; emerging market mutual funds, which focus on investments in developing economies worldwide; and Latin America-focused mutual funds that invest in countries like Brazil, Mexico, and Argentina.

The main advantage of regional mutual funds is that they allow investors to capitalize on the growth potential of specific geographic areas and diversify their portfolios internationally. However, these funds also carry unique risks, such as political instability, currency fluctuations, and economic uncertainties, though they depend on the region.

Sector and theme mutual funds

Sector mutual funds aim to profit from the performance of specific sectors of the economy, such as finance, technology, or health care. Theme funds can cut across sectors. For example, a fund focused on AI might have holdings in firms in health care, defense, and other areas employing and building out AI beyond the tech industry. Sector or theme funds can have volatility from low to extreme, and their drawback is that in many sectors, stocks tend to rise and fall together.

Socially responsible mutual funds

Socially responsible investing or so-called ethical funds invest only in companies and sectors that meet preset criteria. For example, some socially responsible funds do not invest in industries like tobacco, alcoholic beverages, weapons, or nuclear power. Sustainable mutual funds invest primarily in green technology, such as solar and wind power or recycling.

There are also funds that review environmental, social, and governance factors when choosing investments. This approach focuses on the company’s management practices and whether they tend toward environmental and community improvement.

Pros and Cons of Mutual Fund Investing

There are many reasons that mutual funds have been the retail investor’s vehicle of choice, with an overwhelming majority of money in employer-sponsored retirement plans invested in mutual funds. The SEC, in particular, has long paid very close attention to how these funds are run, given their importance to so many Americans and their retirements.

Pros

1. Liquidity
2. Diversification
3. Minimal investment requirements
4. Professional management
5. Variety of offerings

Cons

1. High fees, commissions, and other expenses
2. Large cash presence in portfolios
3. No FDIC coverage
4. Difficulty in comparing funds
5. Lack of transparency in holdings

Can Mutual Fund Shares Be Sold At Any Time?

Yes, mutual funds are considered liquid assets, and shares can be sold anytime. When you sell all or part of your fund holdings, you’ll need to identify a cost basis for that sale. While mutual funds themselves only price their shares once per day based on NAV, you can place orders to sell their mutual fund shares at any time. Review the fund’s policies for exchange or redemption fees. There may also be tax implications for capital gains earned with a mutual fund redemption.

TODO

1. How to invest in Mutual Funds? https://www.investopedia.com/mutual-funds-types-strategies-8611142
2. Can Mutual Funds Use Leverage? https://www.investopedia.com/ask/answers/102215/can-mutual-funds-use-leverage.asp
3. Why Buying Mutual Funds From a Bank Might Not Be a Smart Move https://www.investopedia.com/bank-mutual-fund-disadvantages-8740589
4. How Mutual Funds Pay Dividends https://www.investopedia.com/articles/investing/082415/how-mutual-funds-pay-dividends-overview.asp
5. 4 Investment Strategies for Managing a Portfolio of Mutual Funds https://www.investopedia.com/investing/strategies-for-managing-portfolio-of-mutual-funds/
6. The ABCs of Mutual Fund Share Classes https://www.investopedia.com/articles/mutualfund/05/shareclass.asp
7. The Basics of Determining Taxes on Mutual Funds https://www.investopedia.com/articles/investing/091715/basics-income-tax-mutual-funds.asp
8. Understanding Mutual Fund Fees https://www.investopedia.com/articles/mutualfund/13/12b1-understanding-mutual-fund-fees.asp
9. Why Choose Mutual Funds Over ETFs? https://www.investopedia.com/articles/investing/111115/5-reasons-choose-mutual-funds-over-etfs.asp

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1. Index funds