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Mutual Funds: Know the Basics and Benefits

Almost half of all households in the United States invest in mutual funds.* Whether you are part of that group or considering investing for the first time, it’s important to understand the fundamentals of this widely held investment product.

Introduction to Mutual Funds

When you invest in a mutual fund, your money is combined with the money of many other investors. Professional fund managers use this pool of money to create a portfolio of investments, which may include:

  • Stocks: ownership shares in publicly held companies
  • Bonds: interest-bearing certificates issued by governments and corporations 
  • Money Market Securities: short-term instruments, such as U.S. Treasury bills and certificates of deposit, that mature in less than one year

Each mutual fund has specific investment goals that can range from long-term growth to current income. In addition, a fund may invest in specific types of investments to reach its goals, such as dividend-paying stocks, international investments or long-term bonds.

Owning shares of a mutual fund is similar in some ways to owning shares of stock in an individual company. The mutual fund company will ask you to vote for its board of directors and to help determine other company matters. The mutual fund also may pay you dividends from the securities in which it invests or capital gains that the fund made from selling securities.

Meaning of Share Price and Total Return

A mutual fund’s share price, which is referred to as its net asset value or NAV, is determined at each day’s market close. The price reflects the closing value of all of the investments the fund holds in its portfolio on that day.

Like stocks, the daily price of a mutual fund may go up or down. A fund’s share price can give you an idea of how a fund is performing on a day-to-day basis.

A fund’s total return shows you how much the fund’s shares appreciated or depreciated over the long term and takes into account any distributions of dividends or capital gains. Total return generally is stated as an annual percentage rate.

Top Three Benefits of Mutual Funds

According to mutual fund investors, the most important benefits of mutual fund investing are professional management, investment diversification and convenience.**

1)    Professional management. You can rely on the expertise of professional portfolio managers to select investments for the fund. This can be especially valuable during times of volatile prices and uncertain market direction.
2)    Investment diversification. A mutual fund allows you to spread your money among many different securities. Whether you invest in one mutual fund or several, keep in mind that your investments should include a mix of stocks, bonds and money market securities to lower your overall investment risk.
3)    Convenience. It’s easy to buy and sell mutual fund shares, exchange shares between funds and reinvest your distributions of dividends and capital gains.

Issues in Selecting Funds for You

When selecting or evaluating a mutual fund, look at the fund’s performance over the long term. Consider periods such as one year, five years and 10 years. Keep in mind that past performance is no guarantee of future results. And there are important factors to consider in addition to a fund’s performance. For example:

•    Your risk tolerance and investment time horizon
•    The fund’s objectives and investment style
•    The tenure of the fund’s manager(s)
•    The stability of the fund company
•    The fund’s compatibility with your investment goals
•    The fees associated with investing in the fund

Analyzing these factors and long-term performance can provide you with a complete picture. Be sure to read the prospectus carefully before investing or sending money. A mutual fund’s prospectus includes details of its objectives, investments, fees and other information.

*Source: Investment Company Institute, June 2004
**Source: Investment Company Institute, October 2002

This information is for educational purposes only and is not intended as investment or tax advice.
This article is from the Financial FYI® series produced by the Education & Guidance department of American Century Investments. "Financial FYI" is a registered mark of American Century Services Corporation.

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2 Responses to Mutual Funds: Know the Basics and Benefits

  1. Dr. Awde says:

    for anyone interested in learning about investing tdameritrade.com is also a good site. Their investing classroom is very helpful.

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