how does the stock market work? > stock market basics > unbiased mutual fund advice > definition of a mutual fund

Definition Of A Mutual Fund

The simple definition of a mutual fund is a group of stocks, bond and other securities. This creates a diversified portfolio for the investor or investment company and mutual funds are less of a risk than investing in individual stocks. This is because investors are able to spread their money across a varied collection of securities which include stocks, bonds and money market instruments. Therefore, the investor is not "putting all his eggs in one basket" with just one stock or one type of security.

Money is earned from the mutual fund in four ways.

* Dividends on stocks
* Interest on bonds
* Capital Gains
* Profits from the share's increase in price

With mutual funds, the small investor can buy into the fund with a relatively small amount of money and make small monthly investments with a full time manager of his or her invested money. The fund is diversified so that the risk is spread over several shares. This allows a loss in one investment to be minimized by gains in the other investments.

A mutual fund is also very easily liquidated. It can easily be converted into cash at the investor's request. With the simplicity, lower risk and low investment cost, mutual funds are very good for beginning investors or investors who can't or don't have time to spend on watching the stock market.

There are some disadvantages of mutual funds. The "professional management" of the funds may be inferior and not as qualified as an investor would like. They may not manage the money appropriately, but they still get their commission even if they do a lousy job.

Beyond The Definition Of A Mutual Fund

Another disadvantage is the costs, sometimes hidden costs, that are attached to the funds. These costs can become very complex and difficult to decipher. The taxes are another cost that can come into play. There are some situations, such as a fund manager selling a security, triggering a capital gains tax, where a fund may not be as profitable due to the taxes involved.

Dilution of the investor's portfolio is another possible disadvantage. When the portfolio becomes too diversified the high returns that come from a few investments do not have much impact on the overall return. This can also occur when a successful fund grows too become too large. When funds have strong success, the money that is allocated to those funds may pose a problem to the manager who is attempting to find an appropriate investment for the new money.

Mutual funds can be a lucrative investment for investors of all levels. They are simple, present less of a risk than stocks and allow more of a hands off approach to investing. Additionally, shareholders are free to sell their shares whenever they desire. However, just as with any type of investment, there are situations that may arise with mutual funds that may pose some level of risk and there are still losses experienced. But for those willing to take the risk, mutual funds can offer some great rewards.

And to think all you were looking for was the definition of a mutual fund.

Penny Stockss

Beginner Investor

Advanced Trader

Prudent Investing