A mutual fund is an investment tool where money from many different people (investors) is pooled together to buy a collection of stocks, bonds, or other securities.
How it works
1. The “Pooling” Concept
- Instead of you buying just one share of Company A and one bond from Government B, the fund manager takes thousands of investors’ money and buys a large, diverse portfolio of hundreds of different securities.
- You own a small slice (shares) of this entire large, shared portfolio.
2. Professional Management
- A team of expert fund managers decides what to buy and sell within the fund. They research companies and markets to try and make the best investment choices according to the fund’s goals. This saves you the time and effort of doing complex research yourself.
3. Built-in Diversification
- This is the main benefit. The fund is highly diversified, meaning your risk is spread out.
- Example: If you own a share in a single company and it goes bankrupt, you lose everything. If you own a mutual fund that holds 100 different companies, and one goes bankrupt, it only slightly affects the overall value of the fund.
4. How You Make Money
You benefit from the fund in three main ways:
- Income: The fund passes on any dividends from stocks or interest from bonds it holds.
- Capital Gains: When the manager sells a security for more than they paid for it, that profit is distributed to investors.
- Net Asset Value Appreciation: The value of the fund’s underlying assets increases over time, making each share of the mutual fund worth more when you decide to sell it.
In essence, a mutual fund is a convenient, professionally managed, and diversified way to invest in the market.