Originally created 05/04/02

Investing 101: What are mutual funds?



A mutual fund is an investment that spreads money across a diversified portfolio of securities - including stocks, bonds, or money market instruments.

People who invest in a fund own a representative portion of those investments, less any expenses charged by the fund.

Mutual fund investors make money either by dividends and interest from their investments, or by the rise in value of the securities. Dividends, interest and profits from the sale of any securities (capital gains) are passed on to the shareholders in the form of distributions.

There are a variety of reasons why investors might choose mutual funds over other investments, such as individual stocks and bonds. The No. 1 reason is diversity, which can increase potential returns and decrease overall risk.

Another is professional management. By choosing funds with good long-term track records and low expenses, investors can build a portfolio with the potential for steady, long-term returns that match their investment goals and risk tolerance.

Liquidity is another benefit. Funds can be sold on any business day, when the markets are open, at that day's closing price - or at the next day's close if the sell order is placed after the market closes.

The price per share at any given time is known as the net asset value, or NAV, which is the current market value of all the fund's assets, minus liabilities, divided by the total number of outstanding shares.

Different funds may have different "fund objectives." Typically these are income, growth and income, growth, and aggressive growth. There are also tax-exempt funds, in which the earnings may be exempt from federal and, in some cases, state tax.

With more than 8,000 mutual funds available, finding the fund that matches your investment strategy can be a challenge. There are many sources of information, including Web sites maintained by fund companies.

As with any investment, you should read and understand the prospectus before investing.

Richard L. Norman is a registered investment advisor for Norman & Burdette in Augusta.