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What Is A Mutual Fund?

A mutual fund is a type of investment which pools money from a large number of individual investors and then uses this pool to purchase a variety of investments. The mutual fund will then issue shares of which there price is based on the total value of pooled assets divided by the total number of shares issued. Mutual funds will normally focus on specific sectors or strategies to reflect consumer demand and goals. As a result of this customization there are mutual funds which focus on stocks, bonds, money markets, foreign stocks, indexes as well as growth, growth and income, technology and too many others to list. This is great for investors as it provides ample opportunities to select a mutual fund which reflects their investment strategy.

The characteristics which make mutual funds attractive to individual investors include diversification and professional portfolio management. Diversification in a mutual fund results from shares being purchased from multiple companies to reflect the mutual fund's underlying investment strategies. For example, a technology mutual fund is likely to own shares from as many as 50 different technology companies. Instead of an individual investor having to juggle 50 different technology stocks in their online brokerage account they can buy shares in one technology mutual fund. Diversification works hand-in-hand with professional management. The mutual fund portfolio manager is responsible for selecting the stocks, in the case of a stock mutual fund, which make up the mutual fund's assets. By having access to analytical tools, SEC reports and technical charts they are supposed to be able to pick the winning stocks that mere mortals are unable to find. Mutual funds don't operate on their own however and professional management doesn't come cheap.

To operate a mutual fund it requires investment professionals and support staff as well as meeting SEC requirements for reporting and maintaining accounting practices. To cover these costs, mutual funds charge management fees also known as 12b-1 fees. There may also be other associated fees or a sales commission. A sales commission is a differentiates between load and no load mutual funds. Load mutual funds used to be popular because the assumption was investors get what they pay for and better mutual funds with better portfolio managers cost money. Fortunately, that incorrect line of thinking has disappeared since no load mutual funds have proven investors can receive exceptional performance without paying for additional 12b-1 fees. By law mutual funds are required to provide a prospectus to all potential investors outlining their investment strategies and any and all associated fees and commissions. Be sure to read the prospectus carefully and call the toll free number if you have any additional questions before investing in a mutual fund.

Mutual funds have a few additional considerations pertaining to administration and tax implications. Under SEC rules, a mutual fund must disburse all capital gains accumulated through the year to mutual fund shareholders. Certain investors may find it more beneficial to own individual shares of stock so they can determine their sell dates to minimize capital gains taxes. The reason why a mutual fund will have gains is related to trading activity also referred to as portfolio churn. Mutual funds with high levels of portfolio churn often have increased expenses and, if performance is high, increased capital gains. As outlined in the prospectus, a mutual fund will describe its trading activity levels and the number of companies it invests in and for how long.

Individual or new investors can benefit greatly from investing in mutual funds due to professional management and built-in diversification. That's not to say that a mutual fund won't decrease in value if there is a market correction in either stocks or bonds, but it is safer than owning the individual financial instruments. Read the provided prospectus thoroughly and ask any questions necessary to acquaint yourself with mutual fund requirements and terminology. If you have additional questions it is recommended to speak with a certified financial planner or other investment professional.