A mutual fund is an investment that allocates its assets to stocks, bonds or other securities. Mutual funds have a fairly simple structure in general but there are many types of funds. Understanding how mutual funds work and the characteristics of the various types of funds are vital in choosing a fund to invest in.
Mutual funds are comprised of many different investments. Having many stocks, bonds, or securities comprising the fund allows the fund to achieve diversification. This way if an individual investment of the fund performs poorly it will be balanced out by other performing assets in the fund. This reduces the downside investment risk compared to buying individual stocks or bonds.
Most mutual funds are categorized as having a “load” or “no-load” feature. Many “load” funds require the investor to pay an up front fee based on percentage points of the investment to purchase the fund. Some “load” funds instead require the investor to hold the fund for several years or face a percentage fee for selling before this period expires. “No-load” funds have no upfront costs but the investor should look at the annual costs of the fund or the “12b-1 fees.”
Both “load” and “no-load” funds have 12b-1 fees which are the costs to market and manage the fund during the year and usually range from 25 to 200 basis points(as high as 2%). Most mutual funds are also classified as open-end or closed-end funds. Open-end funds can be bought and sold at anytime allowing the total assets of the fund to fluctuate. Closed-end funds usually only have certain “windows” when investors are allowed to buy or sell their funds, making it easier for this type of fund to manage its total assets and allowing the fund to keep less cash on hand for redemptions.
There are many types of mutual funds, including gold mutual funds. They are often categorized by the market capitalization of the stocks they invest in. Market capitalization of a stock is determined by its total shares outstanding multiplied by its current market price. These are broken down into micro-cap, small-cap, mid-cap, and large-cap funds with large-cap companies usually having market caps of over $1 billion. Mutual funds can also be categorized by the sector or industry that they invest in.
“Technology funds” and “Healthcare funds” would invest in technology and healthcare stocks, bonds and other investments respectively Other fund types are “Index Funds” which mimic the performance market indexes. Many of these funds are designed to follow the performance of the S&P 500, Russell 2000, or other market indexes.