Mutual Funds Investing - How It Works

A mutual fund is simply a company that pools together the money of various investors for the purpose of making several different of investments. This collection of investments-which can be made up of stocks, bonds, and money market funds-is referred to as the portfolio.

The responsibility for managing mutual funds is assigned to a professional investment manager, whose sole function is to buy and sell securities with the goal of increasing the fund in the most effective manner possible. Investors in a mutual fund in essence become shareholders of the mutual fund company. Obviously, the state of the mutual fund directly affects each individual investor. When the mutual fund profits, investors earn a dividend. When the mutual fund suffers a loss, the value of the investor's shares will decrease.

Mutual funds are, by nature, diversified types of investments. What this simply means is that they are comprised of many different investments. The implication of this for the investor is they can avoid having all of their eggs in one basket so to speak. And there is generally a much lower risk involved.

It is of course the responsibility of the fund manager to make sure that the mutual fund performs as well as it possibly could. This is after all what the investor's are paying him or her for. With the fund manager's income based on how effectively he or she is able to increase the fund, it is in their best interests to make sure that it performs well.

Because investors assign the job of managing the fund to someone else, they do not have to bother with diversifying the investments themselves or even keeping their own records. In most cases, investors can simply buy stocks and forget about them. Of course since it is your money that is at stake, you will want to be informed about the status of your investments from time to time.

Mutual funds fall into three main types:

Equity funds - These are comprised of investments of common stock. These generally earn more money than other types, although they may be riskier.

Fixed-income funds - These are government and corporate securities that offer a fixed rate of return. These are generally pretty low risk investments.

Balanced funds - These investments are made up of both stocks and bonds and they are generally mid- to low-risk.

While low risk investments may seem like a good idea-and they in fact are-they will also offer a lower rate of return. It is important therefore to decide what risk-to-return ratio you are most comfortable with, and make your investments accordingly. Careful research is key in finding a mutual fund that offers the level of risk you are willing to take and the returns that you want.