A mutual fund is a pool of stocks or bonds managed by professional investors and sold, in pieces, to common investors. While the securities included in each fund are selected based on a particular investment strategy, funds come in a variety of different shapes and sizes. A fund can include 20 securities, or it can include 500 securities. It can also be based on the type of securities included (for example, technology or medical companies) or it can be based on the size, type and performance of the companies included in it (for example, all Fortune 500 companies or all international companies). Here's how it works:
The company that runs the fund will hire a portfolio manager to be responsible for the fund and give him or her a certain amount of money to invest in it. Once goals and strategies for the fund are determined, the manager will then buy and pool securities that will help them meet their goals. This pool is called the fund's "portfolio". Because the fund is made up of a pool of different securities, the value of the fund is based on the overall portfolio, taking into account the gains and losses of each included security. Once the fund is established, shares of the fund are sold to the public and they, in turn, then own a percentage of the portfolio.
Oftentimes, the company that runs the fund will charge fees. These are essentially management fees that they can charge for doing all of the research and work for you. To the average Joe, these fees are well worth the return.
The main benefit of buying a mutual fund as opposed to buying stock in an individual company is diversification. Because the stock market, and the value of any particular company listed on it, is so unpredictable, you decrease your chances of a total flop by leaning on a variety of different companies' results rather than relying on only one. If the stock value of one company in your mutual fund portfolio drops 50% in one day, everyone who own's stock for that company will have lost a lot of money and be very upset. However, if that one company's stock value drops, and all of the other companies (in your fund) stock values increase, then you are more likely to break even or come out ahead.
This is not failproof. It is still possible that all of the stocks in the fund may decrease in value, thus decreasing the overall value of the mutual fund that you bought, but the fluxuations will be much more even and your chances of coming out ahead are greater. In an average market period, 75% of today's mutual funds beat the benchmark S&P 500 index.
Another obvious benefit of mutual funds, which ties into their performance, is the fact that they are managed by professional fund managers. These people are given access to tons of information that help them determine what companies should be valued at and which stocks will outperform others. Remember, they are determined to make their funds do well since it is not only your money at risk, but their careers as well! They will do whatever they can to keep a successful fund running.
*More articles on Mutual Funds will be coming soon - check back often!
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