Mutual fund

Definition

A mutual fund is a type of investment vehicle that pools money from multiple investors to collectively invest in a diversified portfolio of stocks, bonds, or other securities.

What is a mutual fund?

The fund is managed by a professional investment manager or team, who make decisions on behalf of the investors regarding which securities to buy, sell, and hold.

Here are some key points about mutual funds:

1. Diversification: Mutual funds offer diversification by spreading investments across a wide range of assets. This helps to reduce the risk associated with investing in individual securities.

2. Professional management: The fund’s manager(s) are responsible for making investment decisions based on the fund’s objectives and investment strategy. They conduct research, analyse market trends, and monitor the performance of the investments.

3. Liquidity: Mutual funds are generally considered to be liquid investments. Investors can buy or sell fund shares on any business day, and the fund company is obligated to redeem shares at their current net asset value (NAV).

4. Variety of investment objectives: There are various types of mutual funds with different investment objectives, such as growth (aiming for capital appreciation), income (focus on generating regular income), balanced (mix of growth and income), and more specialised funds like sector funds or index funds.

5. Professional fund management: The expertise of the fund manager(s) can be particularly beneficial for investors who may not have the time, knowledge, or inclination to manage their investments directly.

6. Fees and expenses: Mutual funds typically charge fees for their management and administration. These can include an expense ratio (covering management fees), sales charges (loads), and other administrative costs.

7. Regulation and oversight: In many countries, mutual funds are regulated by government agencies to protect investors’ interests. They are required to disclose information about their holdings, performance, and fees.

8. Open-end structure: Most mutual funds operate as open-end funds, which means they can issue an unlimited number of shares based on investor demand. The price of the shares (NAV) is determined at the end of each trading day.

It’s important for investors to carefully consider their investment objectives, risk tolerance, and time horizon before choosing a mutual fund. Additionally, they should review the fund’s prospectus, which provides detailed information about the fund’s investment strategy, risks, fees, and historical performance.

Example of a mutual fund

John wants to invest in the stock market but doesn’t have the time or expertise to research and select individual stocks. Instead, he decides to invest in a mutual fund. John selects an equity mutual fund that invests in a diversified portfolio of stocks. He invests £5,000 in the mutual fund.

The mutual fund is managed by professional fund managers who use John’s investment, along with funds from other investors, to purchase a diversified portfolio of stocks.

Over time, the value of the mutual fund’s portfolio may fluctuate based on changes in the stock market. If the stocks in the portfolio increase in value, the mutual fund’s net asset value (NAV) will also rise.

John can choose to reinvest any dividends or capital gains distributions received from the mutual fund, further increasing his investment over time. Alternatively, if John needs to access his funds, he can redeem his shares in the mutual fund, typically by submitting a request to the fund manager.