Mutual Fund Investing: Overview

Paul Rolfes | May 09, 2007 10:48am EDT | Comment

Rating: Unrated [rate it]

Mutual fund investing has emerged as a convenient way for individual investors to allow professional money managers to oversee their investments in equities. One of the most appealing aspects of mutual fund investing is that small individual investors can quickly gain significant investment diversification through even a single mutual fund. In the more volatile area of small cap investing, this can be especially important.

What is a Mutual Fund?

A mutual fund is a pooling of money invested in stocks, bonds, a mix of stocks and bonds (called a hybrid), or money-markets, in which investors purchase a share. Generally, mutual fund managers have a particular focus – it could be large cap or small cap stocks, a sector such as real estate, foreign markets, an investment style such as growth or value, or certain types of bonds, to name a few.

Popularity of Mutual Fund Investing

If it seems as if everyone is investing in mutual funds nowadays, to some degree they are. According to the Investment Company Institute, a Washington-based trade group, nearly 55 million U.S. households, or about half of all households, had invested in mutual funds as of 2006. According to the ICI, that's the highest level of fund ownership since 2001, when 56 million households were active in mutual fund investing.

The ICI reported in its annual mutual fund survey that 96 million individuals are mutual fund shareholders. American investors account for about half of the global mutual fund industry, which had close to $18 trillion worth of assets under management as of 2006, the ICI found.

The mutual fund industry staged a considerable comeback starting in 2005. After a three-year downturn following the tech stock debacle, investors again started pouring money into mutual funds.

One reason for the growing popularity of mutual fund investing is the increase in the number of self-driven retirement plans for U.S. workers. As pension plans have fallen out of favor, more employees are socking away their retirement money in 401(k) plans or other long-term investment options. For the small investor, a mutual fund provides professional management of their money, and a pooled risk.

Outside of company-funded retirement programs, mutual funds also are redeemable, giving investors a chance to get in and out at the current net asset value, minus fees. They provide individual investors an opportunity to diversify their holdings, without sinking too much into any one stock or bond. Moreover, mutual funds investing offers variety, with more than 8,000 to choose from.

Mutual Fund Safety

Mutual funds are generally viewed as relatively safe investments due to the diversification that they offer individual investors. However, a single mutual fund is no more safe than its portfolio of investments. So while there are many blue chip mutual funds that are quite stable and for the risk averse, just a few years ago in the dot com bust there were numerous Internet funds that experienced significant losses as the sector went belly up. Mutual fund companies tout their funds' performances over one, three and five years, and sometimes investors forget that old bromide: past results are not a reliable indicator of future performance. Still, a good mutual fund with a proven track record over five or 10 years is usually seen as likely to continue to give investors satisfactory long-term returns.

Mutual funds carry costs which will reduce your return on investment. And if you invest in a clunker, you're still going to pay the accompanying fees even if the fund loses in value. The most popular mutual funds are “no-load” funds, which carry a deferred sales charge, or load, rather than paying a sales charge at the time of investment.

Unlike some investment options that carry guarantees from the FDIC or other government agencies, mutual funds don't have such insurance, and they can lose money. The government does regulate the mutual fund industry through the Securities and Exchange Commission, which requires mutual funds to fully disclose information about their operations.

Depending on an investor's level of expertise, mutual funds can be purchased through an investment professional, or directly from the mutual fund. Many investors who know what they want now turn to online brokerages to handle their needs.

But just as investing in stocks carries risk, so does mutual fund investing. After all, a mutual fund is nothing more than a collection of stocks.