Mutual funds have become increasingly popular in the US because they offer many choices for investors. They’re also convenient to use and can quickly lead to a diversified portfolio. But what exactly are mutual funds and how do they work? Read on to get a crash course on investing in a mutual fund for dummies.
What Are Mutual Funds?
A mutual fund is a sum of money provided by individual investors, companies or organizations in one big pool. A manager oversees the fund and invests its cash into other assets like stocks and bonds. As an investor, you can apply to join a mutual fund and buy shares from it.
With these shares, you have a piece of ownership in the fund. Because the fund manager is using the fund’s cash to buy diverse assets, investors can easily build up a diverse portfolio without having to invest in different stocks or bonds individually.
A mutual fund is comprised of a board of directors or trustees, the company that starts the fund. There’s also the assets the fund holds – stocks, bonds or other cash. Finally, a mutual fund uses contracts for other services it might need. This could be a custodian bank to hold its assets, auditors, accountants and the investment manager who actively oversees the fund.
Types Of Mutual Funds
There are three terms you should know when it comes to types of mutual funds including two main categories: open-end and closed-end.
Open-end funds do not have a set number of shares. When you buy a share, its net value is determined by the fund’s current assets. When you go to sell that share, the value can be redeemed. Most mutual funds are open-ended.
In closed-end funds, there are a set number of shares sold through an initial public offering. Shares are traded on the open market, making them subject to supply and demand.
Finally, you have load and no load. Load refers to a commission, so on shares with a load you pay a sales commission on top of the net asset value. No-load funds obviously have lower expenses for investors, so they yield a higher rate of return.
How Do Mutual Funds Work?
Now that you know the basic composition and types of mutual funds, let’s see how they work. When you select a mutual fund to invest in, you usually have to apply to join on the company website. When you send the application along with your deposit, the money goes into the mutual fund’s custodian account. The investment manager sees this and verifies the amount and then you’re issued shares.
The portfolio manager keeps tabs on all money flowing in and out of the fund. They use this information to decide when to buy new assets. When the manager makes a deal to buy shares of a large corporation for example, it uses the cash in the mutual fund’s account to pay for it.
When the large corporation’s shares pay dividends to the mutual fund, the fund’s manager makes sure the dividends end up in the custodian account. Those dividends are later paid out to you.
A Guide On A Mutual Fund For Dummies – Final Thoughts
There are so many mutual funds out there that emphasize different things, so it’s important to pick one that matches your investment goals. If you’re not interested in startups, don’t invest in a mutual fund geared toward startups, for instance.
Now that you know the basics of mutual funds and how they work, you can start looking for the right one for you.