What are mutual funds? If you haven’t done much with your retirement savings accounts, you probably haven’t looked closely at which mutual funds you are investing in. If you’re new to investing you may not even fully understand what a mutual fund is and how it works.
The simple explanation is that a mutual fund is a collection of stocks or bonds that were chosen by the fund’s manager as good investments.
Picking a mutual fund can be as confusing as picking stocks in which to invest because there are thousands of choices with important sounding names.
The good news is that a mutual fund can be a less risky choice than an individual company’s stock.
That’s because of the built-in diversification of mutual funds, since they hold investments in an assortment of companies.
Most employer sponsored retirement accounts offer mutual funds as investment options, although some may also offer their own company stock, too.
On a side note, the best practice for retirement savings is NOT to hold a large portion of your savings in a single company’s stock; it’s just too risky.
Correcting this situation should become part of your periodic portfolio assessment and rebalancing activities.
The screenshot above is from the morningstar.com website's fund research tool. This view shows the available categories of funds.
Apart from the built-in diversification of an individual mutual fund, a portfolio should also be diversified across fund categories. This means portions of the portfolio would be invested in large companies, some in small or mid-sized, and some in bond funds. International funds would also be part of a well rounded portfolio.
There is no best mutual fund because experienced investors choose funds according to their investment objectives. Some of these objectives include the level of risk, the market segment such as large companies versus small companies, diversification needs, the fund manager and history, and of course, the expected performance of the fund.
Before buying mutual funds, take a few minutes to understand fees and the cost of investing in managed funds. For more on this, see this article on buying mutual funds.
Note: these are not recommendations. They are examples of what to look for when shopping for mutual funds.
Let’s look at a mutual fund comparison between the Fidelity Blue Chip Growth Fund (symbol FBGRX) and the Fidelity Municipal Income Fund (symbol FHIGX). The first key difference between these funds is that the first is invested in stocks and the second is invested in bonds.
The top 3 holdings in the Blue Chip Growth fund are Apple, Google, and Amazon, followed by other large well-known companies. The top 3 holdings in the Municipal Income fund are state governments of California, Illinois, and New York.
Other aspects of these funds to consider are the strategy and objective statements that describe how the fund is operated. The objective of the bond fund is “Seeks to provide a high current yield exempt from federal income tax.” The Blue Chip fund’s objective is “Seeks growth of capital over the long term.”
Performance of investment instruments is expressed by their past returns, like year to date returns, 1 year, 3 year, 5 year, and so on. As you’ll often see stated, past performance does not guarantee future returns.
Investment research firms serve the purpose of providing mutual fund ratings to assist investors with evaluating fund choices. The most well-known and respected of these firms is Morningstar, Inc., at morningstar.com. Their star rating system is referenced by many financial services companies.
What are mutual funds:
To solidify your understanding and answer the question "What are mutual funds", visit your favorite financial services website, such as Fidelity, Vanguard, TIAA-CREF, or the service provider for your retirement accounts.
Their websites should have a section for researching various investment choices where you can examine all aspects of individual mutual funds.