If you’re considering investing, you may have heard of the term “mutual fund.” A mutual fund is a type of investment security. Mutual funds enable a group of hundreds of investors to put their money together into one single investment, hence the word “mutual.” Mutual funds can be put towards other investments, such as stocks, real estate, assets, bonds, or cash. These investments are known as holdings. One mutual fund may be comprised of several holdings, also known as a portfolio.

Why Pool Your Money?

You might be wondering what the benefit of pooling your money with other investors is and it boils down to the old adage, “strength in numbers.” For most, it’s the ability to diversify and invest in a number of holdings. When you invest on your own, the amount of money you can afford to invest is limited – you might be able to contribute $1,000 dollars. This would perhaps allow you to buy stocks and bonds, but not much else. Mutual funds are more accessible to those who don’t have a huge amount of money to invest. When you contribute money to a mutual fund, it is invested along with money from the other investors into multiple holdings, which are usually managed by a professional, called a fund manager. The fund manager follows all of the holdings and determines how much they are collectively worth. In this way, it is also simpler to invest in mutual funds, as it doesn’t require a lot of knowledge of the market or time spent tracking investments.

Types of Mutual Funds

There are thousands of mutual funds to invest in; however, these can be divided into several categories or types. Primarily, there are stock and bond funds. As the titles suggest, a stock fund is a mutual fund composed entirely of different stocks and a bond fund is a mutual fund composed entirely of different bonds. Index funds are another type of mutual fund; they are based on statistical samples of various securities representing a distinct part of the market. For instance, many index funds involve holdings in companies with large market capitalization.

Weighing Costs and Risks

There are several things to keep in mind when considering investing in a mutual fund. The low cost of the investment is often an attractive selling point.

However, keep in mind that fund managers are paid based on commissions – they take home a percentage of the total assets in the fund. While it’s usually not a lot, it may add up over time. You might be focused on the returns you can expect from your mutual fund. However, keep in mind that returns and risk go hand-in-hand. Risky funds are more likely to yield higher returns, whereas less risky funds will yield lower returns. Ask yourself if you can handle the stress of market downswings. If not, you should settle for a low-risk fund with a moderate return.