Mutual funds are a collection of investments owned by a group of investors that have pooled their money together. The capital can be invested in stocks, bonds, money markets, and many other types of securities, including other mutual funds.

The traditional mutual fund has a fund manager who decides how to invest the pooled capital. Capital gains and dividends earned by the fund are reinvested for the investors or distributed accordingly as dividends. Mutual funds are sold in shares, which fluctuate in value, like stocks. Although when trading funds, purchases and sales must take place between the investor and the company, as opposed to trades between individuals like in the stock market. Mutual funds are known as open-ended investment companies because there is no limit to the amount of shares that can be sold. The number of shares fluctuates based on how much (or little) investors invest in the fund. Although mutual funds are supposedly simpler and safer to invest in than stocks, there are so many types of funds and variances that some education on the matter is needed to make good decisions.

Load vs. No-load

Loaded mutual funds are funds that charge a commission for purchasing shares of the fund. A front-end load is a percentage based charged in the amount invested at the beginning of the investment. A back-end load is charged at the time of sale of the fund, and can be based on a percentage of proceeds and/or the length of the investment.

A no-load mutual fund does not charge a commission for investing in the fund, which makes no-load funds attractive.

Mutual Fund Expenses

Understanding mutual fund expenses is also very important. Both load and no-load mutual funds have expenses which range from about 1.6% to 0.2% or less. The expense percentage is the amount of money the company uses each year for operating the mutual fund (fund manager’s salary, etc.). The lower expense ratio, the better your return on investment (ROI). Generally an actively managed fund will have higher expense ratios than an index fund. This is because index funds do not have fund managers and therefore have lower expenses.

Mutual funds can be purchased through a broker, or indirectly though other plans such as a 401k retirement plan. Although mutual funds are a very popular investment that does not mean that they are good investments. Three out of every four mutual fund underperforms the market, that’s 75%! For this reason, I personally prefer stocks and index funds as opposed to mutual funds. In some cases there could be legitimate reasons for investing in mutual funds, but only if the fund has consistently beat (or tied) the market after expenses and load commission.