Mutual fund is a varied holding of stocks that are managed on behalf of the investors that buy into the fund. A mutual fund allows an investor to take benefit of a diversified portfolio devoid of having to invest a large sum of money.
What is the benefit of a diversified portfolio? It provides protection against rapid market losses of any one particular stock. If a portfolio is spread across 20 stocks, if any one of those stocks quickly loses value the consequence is less than if the portfolio consisted of that one stock by itself. When investing it is all the time a good idea to diversify. The problem for small investors is that they regularly don't have the funds to buy a variety of stocks. Mutual funds allow small investors to advantage from diversification with a small amount of money.
In addition stocks, mutual funds can be made up of a variety of holdings including bonds and money market instruments. A mutual fund is in fact a company and investors that buy into a fund are buying shares of that company. Shares in a mutual fund are bought straightforwardly from the fund itself or brokers acting on behalf of the fund. Shares can be redeemed by selling them reverse to the fund.
There also are downsides to mutual funds. There are generally fees that must be paid no matter how the fund performs, and the individual investor has no say in which securities can be included in the fund. As well as, the actual value of a mutual fund share is not known with the same precision as stocks on the stock market.
Mutual funds are repeatedly a better choice for the small investor than either stocks or bonds. They recommend the diversity that provides cushion against sudden stock market movements and generally provide a greater return than bonds. Obviously, mutual funds can also lose value, particularly in the short term, so short term investors might be better off with bonds which offer a set rate of return.
Some funds are managed by investment professionals who make a decision which securities to include in the fund. Non-managed funds are available. They are generally based on an index such as the Dow Jones Industrial Average. The fund merely duplicates the holdings of the index it is based on so that if the Dow Jones (for example) rises by 5% the mutual fund based on that index will also increases by the same amount. Non-managed funds regularly perform very well, sometimes better than managed funds.
