The definition of mutual funds is the pooling of investors cash to buy securities. The most common types of securities purchased are stocks, bonds, and cash instruments. Currently, there is over 26 trillion dollars of investors money in many types of funds.
Individual funds are not limited to just stocks, bonds, and cash. Many funds pool money together to invest in real estate, gold, and other investments. Before mutual funds came along, these sectors were really hard and not worth investing for an individual investor.
Mutual funds can be separated into two categories, open-end and close-end. Open-end funds allow investors to be in and out of funds at any time with no fees or sales load. A close-ended fund has either a fee and or a sales charge for buying and/or a fee or a sales charge for selling.
Even though the definition of an open ended fund allows you to go in and out of the investment with no sales charge, both types of funds still have other ways in which they make money. The most common fee is an expense ratio, which can be found in the fund's prospectus. Expense ratios can vary widely, so make sure you do your proper homework before investing.
Each mutual fund has a manager, which directs the investments. Typically, the manager of each fund will have a specific purpose for the investments. For example, one fund's purpose might be outpacing a benchmark index, like the S&P 500, using growth stocks. Another funds purpose might be to provide a steady income during retirement using dividends stocks and bonds. Today, there is a fund for just about every time frame and risk tolerance imaginable.
Mutual funds allow an individual investor an easy way to diversify. Imagine the struggle of investing in the top 500 securities in the U.S. by yourself. Not only will your trading fees by outrageous, but also the paperwork and taxes would be too much to handle for the individual investor. It would be a full time job!
The popularity of mutual funds has risen for good reason. They allow you to get a professional manager for your investments for a very low cost. Another advantage that mutual funds give to investors is the ability to invest in markets that were previously unavailable. For example, without mutual funds international investing would be very complex for an individual investor.
Mutual funds are here to stay. There simplicity has many advantages to the individual investor. If you're looking for more then just a definition mutual funds, read this Mutual Fund Guide. It will answer many questions that beginners have, including where and how to get started.
