A
mutual fund is in essence, a company that pools investors’ money to purchase an
assortment of stocks and bonds. The financial securities purchased by mutual
funds are grouped into one family of investments. The investments are chosen by
financial professionals who attempt to find a balance that is in line with a
specific market sector or investment philosophy.
In
ideal situations, a mutual fund’s size and resultant efficiency, combined with
the expertise of the management team, offer investors distinct advantages that
include: expert stock and bond selection, convenience, low fees, and, most
importantly, diversification.
When an individual purchases an investment
security such as stock, the investor’s risk is not hedged; they are fully
exposed to the particular company and the sector in which the stock operates.
In contrast, because a mutual fund is a conglomeration of numerous stocks and
bonds, the investor is exposed to a broader aspect of the market. In addition,
the assortment of stocks will typically include large-caps where dividend
payments will be offered each quarter.
As a
result of a mutual fund’s set-up, the investment is viewed as a more
conservative approach to investing in securities. Typically, the return will be
lower than a well-performing stock, but the exposure to risk is mitigated
through the fund’s diversity.
A mutual fund company possesses a portfolio that
is comprised of an assortment of assets. The mutual fund issues shares of stock
to investors in exchange for cash. A mutual fund, however, does not issue
predetermined shares; new shares of mutual funds are issued as each new
investment is obtained. The investors, thus, become part-owners of the fund and,
in turn, the fund uses the investor’s capital to purchase additional securities.
