What is a mutual fund?

Back to Basic Mutual Funds

A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, or other securities. Legally known as an "open-end company," a mutual fund is one of three basic types of investment company. The two other basic types are closed-end funds and Unit Investment Trusts (UITs).

Here are some of the traditional and distinguishing characteristics of mutual funds:

* Investors purchase mutual fund shares from the fund itself (or through a broker for the fund), but are not able to purchase the shares from other investors on a secondary market, such as the New York Stock Exchange or Nasdaq Stock Market. The price investors pay for mutual fund shares is the fund’s per share net asset value (NAV) plus any shareholder fees that the fund imposes at purchase (such as sales loads).

* Mutual fund shares are "redeemable." This means that when mutual fund investors want to sell their fund shares, they sell them back to the fund (or to a broker acting for the fund) at their approximate NAV, minus any fees the fund imposes at that time (such as deferred sales loads or redemption fees).

* Mutual funds generally sell their shares on a continuous basis, although some funds will stop selling when, for example, they become too large.

* The investment portfolios of mutual funds typically are managed by separate entities known as "investment advisers" that are registered with the SEC.

Mutual funds come in many varieties. For example, there are index funds, stock funds, bond funds, money market funds, and more. Each of these may have a different investment objective and strategy and a different investment portfolio. Different mutual funds may also be subject to different risks, volatility, and fees and expenses.

All funds charge management fees for operating the fund. Some also charge for their distribution and service costs, commonly referred to as "12b-1" fees. Some funds may also impose sales charge or loads when you purchase or sell fund shares. In this regard, a fund may offer different "classes" of shares in the same portfolio, with each class having different fees and expenses.

To figure out how the costs of a mutual fund add up over time and to compare the costs of different mutual funds, you should use the SEC’s Mutual Fund Cost Calculator. Some funds may reduce their sales charges depending on the amount you invest in the fund. At certain thresholds, known as breakpoints, you may receive increasingly lower sales charges as your investment increases.

Keep in mind that just because a fund had excellent performance last year does not necessarily mean that it will duplicate that performance. For example, market conditions can change and this year’s winning fund might be next year’s loser. That is why the SEC requires funds to tell investors that a fund’s past performance does not necessarily predict future results. To understand the factors you should consider before investing in a mutual fund, read Mutual Fund Investing: Look at More Than a Mutual Fund's Past Performance. In addition, you should carefully read all of a fund’s available information, including its prospectus, or profile if it has one, and most recent shareholder report.

There are some investment companies, known as exchange-traded funds or ETFs, which are legally classified as open-end companies or UITs. ETFs differ from traditional open-end companies and UITs, because, pursuant to SEC exemptive orders, shares issued by ETFs trade on a secondary market and are only redeemable in very large blocks (blocks of 50,000 shares for example). ETFs are not considered to be, and are not permitted to call themselves, mutual funds.

Mutual funds are subject to SEC registration and regulation, and are subject to numerous requirements imposed for the protection of investors. Mutual funds are regulated primarily under the Investment Company Act of 1940 and the rules and registration forms adopted under that Act. Mutual funds are also subject to the Securities Act of 1933 and the Securities Exchange Act of 1934. You can find the definition of "open-end company" in Section 5 of the Investment Company Act of 1940.

For information about the basics of mutual funds, read from a list of publications by a variety of organizations.
http://www.sec.gov/answers/mutfund.htm