What Is a Mutual Fund?
A mutual fund has many peoples’ money pooled in together to invest in assets such as stocks and bonds. Because fund managers can buy a variety of stocks and bonds with this bigger pool of money, individual investors can easily access a well-diversified portfolio when they buy “shares” of mutual funds. It’s like owning 1% of 100 different stocks instead of buying one stock. A major benefit? It fluctuate less and is less risky.
Active vs. Passive Management
Most mutual funds are actively managed by fund managers in an attempt to bring about a higher return. The fund managers make frequent decisions to buy or sell assets based on their research and analysis.
On the other hand, a mutual index fund mimics the components of a market index, which is considered passive management. Passively managed index funds tend to be less costly. There are many different indexes (S&P 500, Nasdaq, etc), so there are lots of different index funds too.
It is rare for an actively managed fund to consistently beat index funds in terms of returns. Index funds tend to outperform active funds over a long period of time (10+ years), because the future is very hard to predict, and index funds take less of a fee out of the money pool.
Pros of Mutual Funds
- A mutual fund is already diversified as it contains a basket of assets.
- You can invest relatively small amounts of money if you do not have a large amount to start off with (the minimum contribution often starts from $500).
- Mutual funds are really easy to buy.
Cons of Mutual Funds
- Investors cannot respond to price fluctuations immediately since the fund can only be traded at the end of the day.
- The cost of the mutual fund can be high especially for actively managed funds. This could potentially reduce the return on investment.
- Most mutual funds do not guarantee the principal protection. It’s possible to lose money.