Mutual Funds Made Simple: What Are They & How Do They Work?

April 2, 2020

As many money-minded folks say, your money should be working for you. This saying can manifest in a myriad of ways­ including how you make, save, store, invest, and spend your money. When it comes to storing your money, have you surveyed all your options? Are you maximizing your interest-earning capabilities?

If you’re still in the process of figuring out how exactly to answer this question, that’s okay! Generating a thoughtful answer is a great way to begin pondering how to make your money work for you. Today, we’re tackling mutual funds to add to your list of options for making smart money moves!

What is a Mutual Fund?

A mutual fund is a way of investing money alongside other investors. As described by Investopedia, it’s “a type of financial vehicle made up of a pool of money” gathered by several investors who invest in “securities like stocks, bonds, money market instruments, and other assets”.

Mutual funds are portfolios managed by investors and professionals. These investors are essentially providing individual consumers who open mutual funds authoritative and professionals management of portfolios. Individuals interested in mutual funds are able to participate in investments that are professionally managed rather than investing in individual stocks, bonds, etc.

How Do Mutual Funds Work?

As mentioned previously, if you are interested in a mutual fund, you select a mutual fund firm or broker with whom to invest your money. Investors will then manage the money you’ve invested based on the mutual funds you’ve chosen.

Types of Mutual Funds

The world of investing is vast, and mutual funds aren’t terribly different. Here are four broad types of mutual funds offered that you might consider:

1. Equity Funds: Equity funds invest primarily in stocks and are typically defined by the size of the companies, the aggressiveness of the investment, or the market they are invested in. Equity funds can be further broken up into subcategories. Depending on your investment style, you can choose between various equity funds.

2. Fixed Income Funds: Fixed income funds invest in corporate or government debt and are paid out in dividends at a fixed rate. Like equity funds, fixed income funds can be broken up into subcategories based on various attributes like the aggressiveness of the investment, i.e. high risk or low risk. Bonds typically make up a majority of these funds due to their low volatility.

3. Money Market Funds: Money market funds are the safest mutual funds to invest in as they consist of risk-free short-term debt issued by the government. Their returns are similar to what one would see in a checking or bank account while keeping the principal amount from being lost.

4. Balanced Funds: Balanced funds invest in a combination of securities (stocks, bonds, etc.). The primary goal of balanced funds is to reduce the risk of exposure across asset classes. Balanced funds are typically a combination of equity and fixed-income funds.

How Can I Invest in a Mutual Fund?

The type of mutual fund you might choose will depend on your financial goals. For example, if you’re planning on retiring in the next five to 10 years, you might have a lower tolerance of risk, and consider a low-risk mutual fund like a fixed income or money market fund. Conversely, if you hope to see higher returns in a shorter period, you might elect a high-risk equity fund.

The amount invested will also affect which mutual fund one chooses. Many mutual funds require a minimum initial investment of $3,000 or more. However, there are a few, like Vanguard, that have low minimums of $100.

Regardless of your investment strategy, there’s likely a mutual fund that will best suit your needs and goals. If you’re in the process of trying to figure out how best to get your money to work for you, consider talking to a financial advisor or money expert about mutual funds and how that could help with your financial portfolio.

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