Mutual funds have been one of my go-to investments for years thanks to their simplicity and convenience. Think of mutual funds as a financial buffet, offering a wide spread of investment options that cater to different tastes and risk appetites. In essence, they pool money from many investors to buy a diverse mix of stocks, bonds and other assets.
As a certified personal finance educator, I’ve seen how mutual funds serve new and seasoned investors alike. Their collective approach offers a one-stop shop for investing in many stocks and assets with little effort on your part. They also provide access to professional fund management at a lower cost than hiring your own portfolio manager.
What is a mutual fund?
A mutual fund is an investment company that pools your money with many other investors to buy a mix of assets, such as stocks and bonds. This asset mix, or portfolio, allows each investor to access a wide range of investments that might otherwise be too expensive or too technical for them to buy on their own.
Mutual fund managers oversee these portfolios and make investment decisions based on market conditions and fund goals. In exchange, mutual funds typically charge investors a percentage of the fund’s value to pay for administrative costs and other operational expenses. This fee is known as the expense ratio.
How do mutual funds work?
Mutual funds operate in a straightforward manner that simplifies investing for anyone, even if you don’t have prior investment experience.
You can make money from mutual funds in five key steps:
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Pooling money. When you invest in a mutual fund, your money joins that of other investors to “mutually” buy assets..
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Shopping for assets. A professional fund manager uses these combined funds to buy a diverse range of assets that typically include stocks, bonds and other investments.
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Checking daily value. At the end of each trading day, the fund calculates how much each investor’s share is worth based on the value of its investments minus its liabilities. This is called the net asset value (NAV) price.
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Buying and selling shares. Unlike stocks, mutual funds trade only once per trading day. You can buy more shares or sell your shares at the daily NAV price, and the fund executes your trades at the end of the day.
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Sharing profits. The fund may sell some investments for a profit or earn money from its investments, such as dividends from stocks. The fund pays out these profits or income to you based on your share.
The story doesn’t end there — the fund manager continues to monitor performance and makes changes when needed to align the fund with its investment objectives and keep it on track.
5 most popular types of mutual funds
There are many types of mutual funds covering about every asset class and investment strategy you can think of. However, you’ll typically encounter about five main types.
1. Stock funds
These mutual funds primarily focus on stocks. They aim to achieve higher profits by investing in hundreds or even thousands of stocks at the same time. However, these higher profits come with bigger potential losses because the stock market tends to be more volatile.
Some stock mutual funds invest in specific stock market sectors, such as energy, utilities or health care. Others invest in geographic regions or specific national or global markets. You can also find stock funds that focus on companies with specific total values or capitalizations. These include large-cap companies valued at more than $10 billion, mid-cap companies valued at $2 billion to $10 billion, and small-cap companies valued at $250 million to $2 billion.
2. Bond funds
These funds invest in loans to companies and governments, called bonds. When you invest in a bond, you’re essentially lending money to the company or government that issued the bond. In exchange, you receive regular interest payments on your bond.
Bond funds can focus on different types of bonds, from low-risk federal government bonds to higher-risk corporate bonds that offer higher returns. Bond funds are typically less risky than stock funds, but they might not grow as much over time. Their stability makes them a great tool to balance out the ups and downs of stock investments.
3. Money market funds
Not to be mistaken with money market accounts, money market funds invest in safe, short-term loans to the federal government or major corporations. These loans — known as short-term debt securities — typically offer more interest than traditional savings accounts while remaining pretty safe.
The investments in these funds typically mature in a year or less, making them highly liquid. They’re also high quality since established large companies and the federal government typically backs them, making them a decent interest-paying alternative to traditional bank accounts.
4. Balanced funds
These mutual funds mix stocks and bonds together to balance riskier assets with steadier assets. This balance allows these funds to benefit from the stronger growth potential of stocks while earning a steady income from bonds.
Balanced funds are great for investors who want the benefits of both worlds without investing in multiple mutual funds. These balanced funds typically invest about 60% of their pooled money in stocks and 40% in bonds. This allows you to avoid the volatility of a pure stock fund and enjoy potential higher returns than pure bond funds.
5. Index funds
Instead of trying to outperform the market, index funds aim to match it by investing in all stocks or bonds monitored by a specific market tracker or index. For example, the S&P 500 index tracks the 500 largest U.S. companies by market capitalization, so an S&P 500 mutual fund buys stocks of these 500 companies.
This approach requires less management than actively managed funds, lowering expense ratios and translating into smaller fees for you. This approach also makes them a great way to invest in the overall market without spending hours of your time individually selecting hundreds of stocks.
Benefits of mutual funds
Putting your money in mutual funds gives you several advantages, including access to professional management, low fees and portfolio diversification.
1. Professional fund management
Unless you invest in index funds, your mutual funds are typically managed by financial professionals who analyze the market and make investment decisions on your behalf. When I first began using mutual funds, I was relieved that I didn’t have to spend as much time doing my own research, knowing that experienced managers were at the helm. That’s why mutual funds can be quite useful if you lack the time, knowledge or interest to manage your own investments.
2. Low fees
Most mutual funds have low annual fees. These fees, typically expressed as expense ratios, are a percentage of your investment in each fund. In 2023, the industry average expense ratio was 0.42% for stock funds and 0.37% for bond funds, according to the Investment Company Institute. This means you’d pay $42 a year for every $10,000 in stock funds and $37 a year for every $10,000 for bond funds.
In my experience, I’ve found it quite easy to find mutual funds with even lower fees. For instance, the Vanguard Total World Stock Index Fund (VTWAX), which tracks over 9,000 U.S. and international stocks, has an annual expense ratio of 0.10% or $10 for every $10,000.
3. Affordable investments
Many mutual funds have low minimum requirements, which makes it easy for you to start investing with a small amount of money. Some of the mutual funds I use, including the Fidelity 500 Index Fund (FXAIX), have $0 minimums. Vanguard’s VTWAX requires a $3,000 minimum — however, if I were to individually buy each of the stocks in this fund, my cost would be well over $3,000.
4. Simple diversification
Mutual funds offer instant portfolio diversification by spreading your investments across numerous assets. For example, Vanguard’s VTWAX distributes my money over more than 9,000 stocks in the U.S., Japan, the U.K. and more. This minimizes the impact of a single underperforming stock on my overall investment.
5. Convenient bookkeeping
Mutual funds handle the administrative tasks for you, including record keeping and tax preparation. You should receive a statement each month detailing your fund’s performance, investments and fees. During the tax season, you’ll receive a 1099-DIV form from your brokerage, which includes a consolidated view of your earnings that you’ll report on your tax returns. you can link tax software to your investment account to automatically pull the info you need to accurately report your profits on your tax return
Drawbacks of mutual funds
While mutual funds have many benefits, they’re not without a few disadvantages, including the limited control you have over the investments they make and the potential for losing money.
1. Lack of control
When you invest in a mutual fund, you essentially hand over your money to the fund manager. You can’t control which specific assets the fund buys or sells, or when these transactions happen. This limits your ability to time the market or take advantage of daily market fluctuations that day traders typically use to turn a profit.
However, keep in mind that timing the market is a challenging strategy that comes with high risk. As someone who prefers to sit back and let someone else do the work, I prefer handing over the reins to someone whose job is to learn as much as they can about the market.
Dig deeper: Best low-risk investments for retirees
2. Potential for loss
Because your money is broadly invested across different assets, mutual funds can be less risky than individual stocks, but their values can fluctuate daily. Like most investments, past performance doesn’t guarantee future returns, and so you shouldn’t invest in mutual funds unless you can absorb periodic losses.
Value fluctuations are one of the ways mutual funds differ from high-yield savings accounts and money market accounts. These cash accounts don’t invest your money in the market, so you can’t really lose your original investments due to market fluctuations.
Dig deeper: Best high-yield savings accounts
How to invest in mutual funds
Investing in mutual funds is a straightforward process. You’ll need an account at a brokerage firm or a mutual fund company. From there, you can research and make your investments.
1. Choose a brokerage or investment platform
Start by selecting your broker or investment platform. This can be a traditional brokerage firm, an online platform or even a mutual fund company. As someone who prefers simplicity, I like platforms that only give me the essential information I need. That’s why I use SoFi Invest, which charges no commission fees and offers access to over 6,000 mutual funds. Other platforms I’ve used and loved include Charles Schwab and Fidelity for their wide offerings and incredible support teams.
2. Research available mutual funds
Look for a section dedicated to mutual funds on your investment platform. For example, SoFi lists available funds based on the sectors they focus on.
You can also search for specific funds — for example, I looked up the VTWAX mutual fund to get more information about its performance and fees.
In the green box, you can see the fund performance over the past three months, one year, five years and more. The blue box is where you can view your initial minimum investment and subsequent minimum investments. The red box shows applicable fund fees. Keep in mind that your view will vary based on your platform.
You can easily find more information by searching the fund’s name on Google and visiting its website. For example, Vanguard’s VTWAX page provides additional details on the fund’s focus, portfolio composition, markets or regions it covers and a complete list of assets it contains.
3. Understand and compare fees
Pay close attention to the fund’s fees, as they can significantly impact your returns over time. Common types of fees to watch out for include:
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Expense ratio. This is the annual fee that you pay for the management of the fund. It’s a percentage of your total investment. For instance, VTWAX has a 0.01% expense ratio.
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Load fees. These are commissions that can come as front-end load fees for buying shares in a fund or back-end load fees for selling your fund shares. These fees are less common nowadays, as many mutual funds are no-load funds — meaning they don’t charge this fee. In our VTWAX example, you can see that it has no load fees.
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Redemption fees. These are fees you pay for selling your shares soon after buying them to recoup the resulting costs of your trade. The U.S. Securities and Exchange Commission limits this fee to no more than 2%. But many funds, including VTWAX, have no redemption fees.
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12b-1 fees. These fees cover marketing and distribution costs. As these are operational costs, many funds group these fees into their expense ratios.
4. Buy shares in your chosen fund
Once you’ve chosen a fund, make sure you have enough available funds in your brokerage account and then buy or place your order on your investment platform. When you enter your initial investment amount, you should see the number of shares the amount will buy:
Keep in mind that making a single investment into a mutual fund locks you in at the fund’s share price on that specific day. Instead, consider making regular investments using a strategy called dollar-cost averaging. This means investing a fixed amount at regular intervals, regardless of the fund’s price.
For example, you might invest $500 every month. When the fund’s price is lower, your fixed investment amount buys more shares. When the price is higher, it buys fewer shares. Over time, this strategy helps smooth out the effects of market volatility. I employ this strategy for all my investments, and it’s been effective at growing my portfolio over time without stressing about temporary market conditions.
Mutual funds vs. other fund types
Mutual funds aren’t the only funds you can invest in. Two other common types are exchange-traded funds (ETFs) and hedge funds.
Mutual funds vs. exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) are similar to mutual funds in that they offer diversified portfolios of assets such as stocks and bonds. However, while mutual funds trade once a day after market closure, ETFs trade throughout the day like normal stocks.
ETFs often have lower expense ratios and minimum investment requirements than mutual funds. The average expense ratios for bond and stock ETFs ranged from 0.11% to 0.15% in 2023, compared to 0.37% to 0.42% for mutual funds, according to the Investment Company Institute.
Mutual funds vs. hedge funds
Hedge funds are large investment vehicles typically available to high-net-worth individuals (HNWIs) with liquid assets above $1 million or annual incomes above $200,000 for individuals or $300,000 for couples. Hedge funds are also available to institutional investors, such as pension funds and insurance companies.
Hedge funds often use more complex and riskier strategies than mutual funds to aim for higher returns. Hedge funds also tend to charge higher fees than mutual funds.
Many hedge funds have high minimum investments that can range from $100,000 to $10 million or more. That’s why mutual funds are generally more accessible than hedge funds.
FAQs: Investing in mutual funds
When do mutual funds pay dividends?
Mutual funds typically pay dividends to shareholders on a predetermined schedule – often quarterly, semi-annually or annually. These dividends come from the stocks and bonds the fund invests in. As an investor, you can choose to receive these dividends as cash or reinvest them to buy more shares of the fund.
Are mutual funds good for beginners?
Yes, mutual funds can be a great investment for beginners because they offer easy diversification, professional management, and relatively low investment minimums. Investing in mutual funds is generally less risky than investing in individual stocks and doesn’t require in-depth investment knowledge, making them a good starting point for new investors.
How much money should I start with in a mutual fund?
You should start small to give yourself the time needed to understand the investing process. From there, you can gradually build up your mutual funds investments by buying more shares at regular intervals to use the dollar-cost averaging method. This helps reduce the volatility of your investments over time. Keep in mind that some funds may have a minimum initial investment ranging from $100 to $3,000, while others may only require $1 to start.
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About the writer
Yahia Barakah is a personal finance writer at AOL with over a decade of experience in finance and investing. As a certified educator in personal finance (CEPF), he combines his economics expertise with a passion for financial literacy to simplify complex retirement, banking and credit topics. He loves empowering people to make informed financial decisions that improve their everyday and long-term wellness. Yahia’s expertise has been featured on FinanceBuzz, FX Empire and EarnForex. Based in Florida, he balances his love for finance with freediving, hiking and underwater photography.
Article edited by Kelly Suzan Waggoner
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