What Is Mutual Fund?
A mutual fund pools money from many investors to buy a diversified portfolio of stocks, bonds, or other assets. Learn types, fees, and how mutual funds compare to ETFs.
Definition
A mutual fund is an investment vehicle that pools money from thousands of investors to buy a diversified portfolio of stocks, bonds, or other securities. A professional fund manager (or a computer algorithm, in the case of index funds) decides what to buy and sell within the fund. Each investor owns shares proportional to their contribution.
Mutual funds come in two main varieties: actively managed funds, where a manager tries to beat a benchmark index by picking winning stocks, and passively managed (index) funds, which simply track a benchmark like the S&P 500. Active funds charge higher fees (typically 0.5-1.5% per year) while index mutual funds charge very low fees (0.03-0.20%).
Unlike ETFs, mutual funds are priced only once per day, after the market closes at 4 PM ET. All buy and sell orders execute at that day's closing price, called the net asset value (NAV). Some mutual funds have minimum investment requirements, typically $1,000 to $3,000 for initial purchases.
Real-World Example
The Vanguard Total Stock Market Index Fund (VTSAX) is one of the most popular mutual funds in existence. It holds over 3,600 U.S. stocks, effectively giving you a stake in the entire American stock market. The expense ratio is 0.04%, the minimum investment is $3,000, and it has over $1.5 trillion in assets. If the total U.S. stock market goes up 8% in a year, VTSAX goes up roughly 8% minus the tiny fee.
Why It Matters
Mutual funds are the backbone of most retirement accounts. The majority of 401(k) plans offer mutual funds as the primary investment options. Understanding the difference between active and passive funds, and the impact of fees on long-term returns, can be worth hundreds of thousands of dollars over a career. A 1% difference in annual fees on a $500,000 portfolio costs roughly $5,000 per year -- money that compounds against you for decades.
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Frequently Asked Questions
What is the difference between a mutual fund and an ETF?
Both pool investor money into diversified portfolios, but mutual funds trade once per day at closing price while ETFs trade throughout the day like stocks. ETFs generally have lower fees and better tax efficiency.
Are mutual funds a good investment?
Low-cost index mutual funds are excellent long-term investments for most people. High-fee actively managed funds are less attractive because most fail to beat their benchmark index over long periods.
How do mutual fund fees work?
The main fee is the expense ratio, expressed as a percentage of your investment charged annually. A 0.50% expense ratio means you pay $50 per year for every $10,000 invested. Some funds also charge sales loads (commissions) when you buy or sell.
Can I lose money in a mutual fund?
Yes. Mutual funds invest in the market, and markets go down. However, broad index mutual funds holding hundreds or thousands of stocks are less risky than individual stocks because losses in some holdings are offset by gains in others.
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