Investors pool money into a company which the company then invests in securities. These securities include bonds, stocks, and debt that is short term. Everything that is invested by the company is called a portfolio. The investors, then, buy shares of this company. These shares are indicative of the investor’s ownership of the company and the money it generates. This company is what is known as a mutual fund.

Despite a few limitations, including the fact that they are not cheap in the long run, not tax efficient and not current, mutual funds remain popular among investors. This is because, for one, mutual funds are managed by professionals who do the research, select the securities you need to invest in and track the performance of the investment and the company, ensuring that the investor does not have to work at this. Two, mutual funds invest in a number of different securities. This diversification ensures safety. If one company performs badly, the investor is not at risk of losing everything he has invested in – a typical case of not putting all your eggs in one basket. Three, mutual funds are affordable because the initial investment is set at a low dollar amount. Four, mutual funds can be easily liquefied. An investor can exchange his shares for money any time he wishes to for the current NAV – net asset value – including redemption fees if any.

Mutual funds, generally, are of four kinds. The first is money market funds which are low-risk funds. They are limited by law to make investments that are short-term and great in quality. These investments are from U.S corporations and the government, federal, state and local. The second kind of mutual funds is bond funds. These come with higher risks as compared to market funds. This is because their goal is to get higher returns. Thanks to the wide variety of bonds available, the benefits and drawbacks of each differ vastly. The third is stock funds which invest in corporate stocks. However, these stock funds vary. For instance, there are growth funds where stocks do not pay dividends on a regular basis but can bring gains that are above average, financially. Then there are income funds where the stock pays dividends that are regular. Index funds, another form of stock funds, monitor a specific market index like the S&P (Standard & Poor) 500. Sector funds, on the other hand, focus on a specific segment of an industry. The fourth kind of mutual funds is target date funds which contain an assortment of stocks, bonds and a variety of other investments. These work well for people who have a specific date for retirement. They are also known as lifecycle funds.

Mutual funds come with their own benefits and drawbacks. The benefits, as already mentioned, are a diversified investment and professional management of investment. In addition to this, they help one earn money through three different ways. One is payments from dividends. A mutual fund earns income from interest rates on bonds on their stocks. The investors then get portions of the income minus the expenses involved. Another form of payment is through capital gains distributions. A capital gain is what happens when a security that has increased in price is sold by a fund. The fund divides these gains among the investors at the end of the year, lesser capital losses. The third form of payment is through an increase in net asset values (NAV). When a portfolio experiences an increase in market value, minus expenses involved, the fund and, therefore, the shares naturally increase in value as well. The higher the net value of the assets, the higher the value of your investment.

It is important to remember that all funds have an element of risk to them. As far as mutual funds are concerned, you can lose a portion of the money or all of the money you have invested should the value of the securities invested in by the fund go down in value. Thanks to changes in market value, the dividend amounts, and interest payments are also subject to change. It is also important to remember that the way a fund has performed in the past is not indicative of how it will perform in the future. On the other hand, the performance of a fund in the past does give a picture of how reliable the performance of the fund was. Naturally, if a fund is volatile in nature, the risk is higher.

You can buy shares from a mutual fund directly from the fund or through someone who does brokerage for the fund. Before buying shares from a mutual fund, ensure that you go through the terms and conditions involved carefully. Companies that run mutual funds have costs, and these costs are charged to the investors in the form of fees and expenses. If the fund charges more, it probably signifies that the returns are better.