What Is a Mutual Fund? A Beginner’s Guide for 2025

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A mutual fund pools money from many investors and puts it in securities such as stocks, bonds and other assets. The combined holdings of the mutual fund are known as its portfolio.

Investors who buy shares in the fund own a portion of it and earn returns as the fund’s investments grow in value.

How Do Mutual Funds Work?

A mutual fund is a collective pool of investments. When different investors buy shares, managers take that money to purchase various securities. While investors don’t own individual assets, they hold a proportional share of the fund based on the number of shares they purchase. All investors earn returns at the same rate.

Understanding mutual funds also means recognizing how it functions in different investment strategies. For example, an equity mutual fund might own 100 or more different stocks. If you invest $1,000 into the fund, you own 10 shares in the fund. You don’t own the securities themselves, and you can’t trade any individual securities within the fund — that’s the responsibility of the fund manager(s). But you participate in the daily gain or loss of the fund, just like every other investor in the fund.

Types of Mutual Funds

Here’s a look at four major types of mutual funds.

• Equity funds: Equity funds invest in the stock of corporations. They may invest in several companies in a given industry, such as technology or energy. The fund may also seek to invest in new companies or those in emerging markets. The stocks may be chosen for their ability to provide income in the form of dividends or growth in the form of price appreciation.
• Bond funds: Bonds are debt instruments that corporations and governments issue when they need to raise money. Although they usually don’t appreciate much in value, bonds often pay dividends that can provide investors with a consistent source of passive income.
• Balanced funds: Balanced funds own both stocks and bonds in an attempt to have consistent growth in any type of market. Often, when bond returns increase, stock returns decrease, and vice versa. A fund that holds both bonds and stocks might be less vulnerable to market volatility.
• Index funds: Index funds try to match the performance of a market index, such as the S&P 500 or the Nasdaq Composite. Fund managers keep the fund’s returns in line with the index, whether it goes up or down. According to Morningstar, index funds typically perform on par with similar actively managed funds and often outperform them over time.

Advantages of Investing In Mutual Funds

Here’s a look at the major reasons you might choose to invest in a mutual fund.

Diversification

Diversification in investing means more than just buying stock in a few different companies, though. A diversified portfolio will include stocks, bonds and cash, and it will be invested in many different industries.

Mutual funds typically have a diverse selection of investments in the fund already, so buying shares of a single fund can do the diversification for you. If you don’t have a large amount of money to invest, mutual funds are an effective way to diversify your investments.

Professional Management

Mutual fund companies hire professional fund managers to choose and monitor the investments in each mutual fund. These people are highly trained, and they spend their days watching the investments in their funds.

• Actively managed funds: Manager will remove underperforming investments and replace them with ones they believe will perform better.
• Index funds: Managers ensure the fund continues to track its designated market index.

Accessibility

Whereas you’d need a large investment to buy a diverse portfolio of individual stocks and other assets, you can invest a small amount of money in a mutual fund. What’s more, you can sell your mutual fund shares on any day the markets are open.

When you do, you’ll get the current price, or net asset value, as of the market’s close, less any fees for redeeming the shares.

How To Choose the Right Mutual Fund

The right mutual fund is one that aligns with your goals while balancing value and risk. Before investing, make sure you understand what is a mutual fund and how different types fit your financial strategy.

• Investing goals: If you’re looking for a mutual fund that might increase in value and let you sell later at a profit, your goal likely is growth. If, on the other hand, you want to earn dividends offering monthly, quarterly or annual payouts, an income fund is your better choice.
• Risk tolerance: Any investment can lose money, but some are more volatile than others. When it comes to mutual funds, stock funds typically have the potential for larger gains, but you also risk greater losses. Bond funds have less potential for appreciation, but they’re also less risky.
• Fees and expenses: Mutual funds charge investors fees to cover operating expenses, and some also charge commissions. These costs reduce your earnings, so it’s important to know how much they are and when you’ll have to pay them. You’ll find the information in the fund’s prospectus.

How To Invest In a Mutual Fund

Here are the specific steps you’ll want to take to invest:

1. Open a new account or add enough money to an existing account at a brokerage that offers mutual funds.
2. Screen potential funds according to your investment objectives and risk tolerance. For example, you might want to prioritize funds by return over a specified period, such as year to date or over five years. You could also screen by fees, minimum purchase amounts or overall risk.
3. Select the amount that you want to invest in one or more funds, and set up your trades with your brokerage. Generally, this involves clicking on the name of the fund and typing in the dollar or share amount you want to purchase. You may also be able to set up recurring investments at the time of purchase. At some brokerages, you can enter your trade over the phone, but you may have to pay additional fees.

Monitoring Your Investments

After you make your purchase, it’s important to monitor the performance and any objective changes of your fund. While you should avoid tracking it from day to day, checking periodically, such as once per month or quarter, is often recommended by advisors. 

If you ever wish to sell your fund, you’ll undertake essentially the same action: Click on the fund in your account, enter the amount that you want to sell, and submit the order to your brokerage firm. 

Costs and Fees Associated With Mutual Funds

As previously noted, you pay fees when you invest in a mutual fund. The fees vary by fund, but here are some of the common ones to look for:

• Expense ratio: The expense ratio is an aggregate of fees that funds charge to cover operating expenses like management, administration, distribution and marketing. The ratio tells you what percentage of the fund’s average net assets go toward these fees, so it’s a good way to compare the cost of one fund to another.
• Front-end and back-end loads: Some funds charge commission when the investor buys or sells. These commissions are called loads — front loads for commissions on purchases, and back loads for commissions on sales.
• Transaction fees: Depending on the fund, you might pay purchase fees when you buy and/or redemption fees when you sell. These transaction fees are separate from sales loads.

Are Mutual Funds Right For You?

Mutual funds can be excellent investments for the right investor. The best mutual funds to invest in are those that have a history of solid performance and low expenses and fees. Each fund has a prospectus, available on the company’s or broker’s website, that gives you the information you need to evaluate its quality and suitability for your portfolio.

Mutual funds are a good choice if you prefer to have someone else make the decisions about which companies to invest in, and if you want to buy and hold your investments. The fees associated with mutual funds make them a poor choice for someone who wants to buy and sell frequently.

John Csiszar and Daria Uhlig contributed to the reporting for this article.

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