Mutual funds have been a cornerstone of investing for decades. If you have a 401(k) or other retirement account, you probably already own one. But many people invest in mutual funds without fully understanding what they are.
What a Mutual Fund Is
A mutual fund is an investment vehicle that pools money from many investors to buy a diversified portfolio of stocks, bonds, or other securities. A professional fund manager (or a team) decides what to buy and sell within the fund.
When you invest in a mutual fund, you are buying shares of the fund, not shares of the individual companies inside it.
How They Work
Net Asset Value (NAV). Mutual fund shares are priced once per day, after the market closes. The price is based on the total value of all the fund's holdings divided by the number of shares outstanding.
Active vs. passive management. Actively managed funds have managers who try to beat the market by picking specific investments. Passively managed (index) funds simply track a benchmark like the S&P 500.
Dividends and capital gains. When the fund earns income or sells investments at a profit, it distributes those gains to shareholders, usually annually. These distributions are taxable even if you reinvest them.
Mutual Funds vs ETFs
Both hold baskets of investments, but they differ in important ways:
| Feature | Mutual Fund | ETF |
|---|---|---|
| Trading | Once per day at NAV | Throughout the day at market price |
| Minimum investment | Often $1,000-$3,000 | One share (or fractional) |
| Expense ratios | Varies widely | Generally lower |
| Tax efficiency | Less efficient | More efficient |
| Active management | Common | Less common |
Types of Mutual Funds
Stock funds: Invest in stocks, categorized by size (large-cap, small-cap), style (growth, value), or sector.
Bond funds: Invest in government or corporate bonds for income.
Balanced funds: Mix of stocks and bonds in a single fund.
Target-date funds: Automatically adjust the stock/bond mix as you approach a target retirement year. Popular in 401(k) plans.
Money market funds: Invest in short-term, low-risk securities. Similar to a savings account but not FDIC insured.
What to Watch For
Expense ratio. The annual fee, expressed as a percentage. An expense ratio of 1% means you pay $10 per year for every $1,000 invested. Over decades, even small differences in fees can cost tens of thousands of dollars.
Load fees. Some mutual funds charge a sales commission (load) when you buy (front-end load) or sell (back-end load). No-load funds do not charge this fee and are generally the better choice.
Performance vs benchmark. If you are paying for active management, the fund should at least match its benchmark index. Most actively managed funds underperform their benchmark over long periods after fees.
The Progressive Trailblazer helps you research and understand whatever you invest in. Educational only. Not financial advice.