Mutual fund
A pooled investment that collects money from many investors to buy a portfolio of stocks, bonds or other assets run by a professional manager.
What it means
A mutual fund lets investors own a slice of a large portfolio with one purchase. Shares are bought and sold directly with the fund at the net asset value (NAV), which is calculated once at the end of each trading day. The fund makes or loses money as its holdings rise, fall, and pay interest or dividends, and investors pay for management through the expense ratio and sometimes sales charges called loads.
Funds can be actively managed, where a manager picks investments, or passively managed to track an index. Their risk depends entirely on what they hold. In a taxable account, investors owe tax on dividends and on capital gains the fund distributes, even if they reinvest them and never sell, plus tax on their own gains when they sell shares.
Formula
NAV per share = (Total assets − Total liabilities) ÷ Shares outstanding
- Total assets = market value of everything the fund holds
- Total liabilities = what the fund owes, such as accrued fees
- Shares outstanding = fund shares held by investors
Example
Suppose a fund holds $101 million in assets, owes $1 million, and has 4 million shares outstanding. Its NAV is ($101 million − $1 million) ÷ 4 million = $25 per share.
How it’s used
- Core investment options in many 401(k) and 403(b) plans
- Getting instant diversification with a modest amount of money
- Automatic monthly investing at an exact dollar amount
Strengths and weaknesses
Strengths
- Broad diversification in a single holding
- Professional management and easy automatic investing
- Fractional shares let any dollar amount be invested
Weaknesses
- Fees, especially for active funds, can noticeably reduce returns
- Taxable capital gain distributions can occur even without selling
- Trades only once a day at the closing price; some require minimum investments
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.