What are Mutual funds? How do they work?

What Are Mutual Funds?

Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. They are professionally managed by fund managers who allocate the fund's assets to achieve specific investment objectives, such as growth, income, or a combination of both123.

How Do Mutual Funds Work?

1. Pooling of Funds: Investors buy shares in a mutual fund, contributing to a collective pool of money. This pool is used to invest in a variety of assets, including stocks, bonds, and money market instruments24.

2. Professional Management: The fund is managed by a professional manager or team who decides which securities to buy and sell based on the fund's investment strategy. This strategy is outlined in the fund's prospectus15.

3. Diversification: Mutual funds offer diversification by spreading investments across different asset classes, reducing risk compared to investing in individual stocks or bonds24.

4. Pricing and NAV: The price of a mutual fund share is determined by its net asset value (NAV), which is calculated daily by dividing the total value of the fund's assets minus liabilities by the number of outstanding shares15.

5. Income and Capital Gains: Investors earn returns through dividend/interest income and capital gains distributions. These distributions can be reinvested or taken in cash23.

6. Fees and Expenses: Mutual funds charge fees, including management fees and operating expenses, which are factored into the fund's overall return34.

7. Types of Mutual Funds: There are various types, including stock funds, bond funds, balanced funds, money market funds, and index funds. Each type has its own investment objectives and risk profiles14.