A mutual fund is a pool of money from many investors that is used to invest in one portfolio of securities for the benefit of all the investors in the fund. Mutual fund investors buy shares in the mutual fund. Each share represents a piece of every investment made by the money managers that oversee the mutual fund. Although mutual funds allow you to invest in many sectors of the economy at once, mutual funds do have limitations worth considering before you invest.
Since mutual funds are professionally managed, you do not have any control in how the money in the mutual fund is invested. Money managers are responsible for researching and interpreting data related to the investments that make up the mutual fund. As a result, you have no way of influencing what investments are bought and sold by the money manager.
The returns you generate by investing in a mutual fund are limited in part by the cost of maintaining the mutual fund. According to the U.S. Securities and Exchange Commission, a mutual fund is similar to a business. The mutual fund incurs costs to buy and sell investments on the open financial market place. Some of these fees may include advising fees, transaction costs, and fees for marketing and distribution. These fees reduce the returns you make from the investments in your mutual fund.
A prospectus for a mutual fund is one of the most common sources of information for investors. A key consideration when you examine a prospectus is that projections of future earnings are only estimates of how the mutual fund may perform in the future. Projections are commonly based on past performance, but there is no guarantee that a mutual fund will generate the same level of returns as past years.
The money you invest in a mutual fund is not insured by the Federal Deposit Insurance Corporation. If your bank participates in FDIC insurance, your deposits are repaid to you if your bank fails, but the money you invest in mutual funds is not protected against investment losses or bank closure.
Mutual funds are exposed to risk like any other investment in the financial markets. Mutual funds try to minimize risk by investing in an assortment of securities like stocks and short- and long-term bonds. This strategy is commonly called diversification, and it protects you from losses in one area of the portfolio with gains in another. While mutual funds invest in several sectors, some specialize in certain investments like money market funds, bond funds and stock funds, which carry additional risk of loss.
- U.S. Securities and Exchange Commission: Invest Wisely: An Introduction to Mutual Funds
- FDIC: Your Insured Deposits
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- Morningstar. "Early Evidence on the Department of Labor Conflict of Interest Rule: New Share Classes Should Reduce Conflicted Advice, Likely Improving Outcomes for Investors," Page 6. Accessed Aug. 3, 2020.
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Gilberto Fuentes draws on his experience in financial services to develop copy for websites in the United States, United Kingdom and Latin America. His work has been published in the online editions of the "San Francisco Chronicle" and the "Houston Chronicle." Fuentes lives in New York and holds a dual Bachelor of Arts in English and economics.