Mutual funds are a complicated word for a very simple investment vehicle. A mutual fund is nothing more than a collection of stocks and bonds which would be very hard to own individually. Each investor in the mutual fund owns a small portion of the fund, just like it would own a part of a company, and the company invests all its money in stocks, bonds, or other securities. Simple, isn’t it?
You can make money using mutual funds in 3 ways:
1) Earn dividends and interest based on the stocks and bonds the fund owns
2) Capital gains
3) Selling your shares of the fund for a profit, just as you would do with any other stock
Of course, mutual funds have their advantages and disadvantages, just like any other financial investment instruments. Their biggest advantages are the fact that they are professionally managed (which is usually a good thing), they have a diversified portfolio that keeps you safe from crashes and they require little to no attention. They do have their drawbacks, however – administration costs and fees are quite high, the gains are usually not great and they are subject to a good number of taxes.
Mutual funds are as varied as you would expect. There are funds investing in a particular index, or in a particular niche of the market. This diversity is good for people who want to carefully choose which fund to invest in due to their investment objectives. For example, if an investor is looking for safety and wants to invest for the long term, a very good choice would be mutual funds that own lots of safe, A+ bonds for long periods of time. Other good ideas are mutual funds that follow indexes or invest almost exclusively in bonds and blue chip stocks.
On the other hand, if you’re looking for short-term gains or big wins, you have to choose riskier funds which invest in less-known companies that could make it big in the near future, or lesser qualified bonds. Higher gains come with a higher risk, as always. Be sure to carefully define your objectives, because once you know why you’re in the game, picking a fund should be an easy task.