Investing for Beginners: Understanding the Basics of Mutual Funds

Education is key to profitable investing. If you have heard the term "mutual fund" but do not know much about these investment instruments, learn the basics of mutual funds before you invest. Then decide if mutual funds have a place in your portfolio.

What Is a Mutual Fund?

A mutual fund is a collection of stocks, bonds or other securities. When you buy shares of a mutual fund, you are not buying stock from a single company. You are buying shares of a group investment that includes many different types of stocks and bonds. Mutual funds are directed by experienced financial professionals who make decisions on behalf of the investors.

How Do Investors Profit From Mutual Funds?

Mutual funds generate three types of profits. Successful funds earn dividends on stocks and interest on bonds; most of those monies are passed on to the investors. When securities funds experience capital gains, the manager distributes most of it to the investors. Some investment firms also retain a portion of the capital gains, which lowers investor costs, maintenance fees and transaction charges. The per-share price of a profitable mutual fund is apt to increase, and investors profit by selling their shares during a price peak.

What Are the Advantages of Mutual Fund Investments?

Mutual funds have several lucrative advantages that make them attractive to many investors. They are directed by seasoned investment managers who have the time and expertise to grow the fund. Most investors are not financial gurus and need professional help to reap maximum profits. Another crucial benefit is diversification, which means that fund monies are spread out over many different investments. Diversification reduces the chance of catastrophic financial loss if one segment of the investment market falls.

What Is Economy of Scale?

Economy of scale refers to bulk transaction discounts. Mutual fund managers regularly buy and sell huge volumes of stocks, bonds and commodities. These gigantic transactions qualify the funds for discounts on transaction costs. These savings are passed on to investors in the form of low fees.

These are the basics of mutual funds, but there is still much more to learn. Mutual funds have many advantages over traditional, individual investments and deserve a place in your portfolio. All investments have associated risks and the potential to lose value, so do not rush to buy the first mutual fund you find. Speak with an investment professional to learn which funds are the best choice for you.

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