A mutual fund consists of stocks and bonds. The fund might specialize in a very narrow area, such as emerging medical companies, or it may acquire stock and bonds that are representative of the entire market. Investors in a mutual fund buy shares of it and receive a proportional share of the fund's earnings. These earnings may be paid out to the investor or automatically reinvested in the fund. Many investment instruments, such as 401(k)s and individual retirement arrangements, invest in mutual funds.
Investing in mutual funds can be advantageous for inexperienced investors who don’t have the time to tend to their investments. A mutual fund provides a degree of diversification. Investing in these funds allows you to rely upon the experience of the fund manager. Unlike many other investments, mutual funds that are not part of a retirement package such as a 401(k) or an IRA are very liquid. Liquidity refers to your freedom to cash out of an investment without incurring a penalty.
The catch to mutual funds is that you give up some control in return for the benefits. You have no authority with respect to choosing what investments go into the fund because that is the purview of the fund manager. You don’t know the minute-by-minute price of the fund. Some funds impose a sales charge, called a “load,” for the privilege of investing. While no-load funds charge no more that 0.25 percent of the total investment, you may be faced with unexpected fees if you need to make changes to your account.
Net Asset Value
The net asset value is the price per share that you pay to invest in the mutual fund. It does not include any of the fees that may also be applicable. Unlike stocks and bonds, the NAV is not necessarily a good indicator of fund performance, because mutual funds are required to pay out all of the money they earn. Your earnings can be quite substantial while the NAV remains unchanged.
The FDIC does not guarantee mutual funds. The security of a particular fund depends upon the nature of the fund, the overall health of the market, the health of the sector in which the fund is invested, and the fund manager’s expertise. You can minimize your risk by investing in funds that have weathered a variety of market conditions over many years. While past performance is no indicator of the future, studying how a fund performed when the market went south suggests what might happen if such conditions recurred.
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