What is a Mutual Fund?

This article will try to explain in very simple terms what is a mutual fund. In simple English, mutual funds are a way to invest money in stock market, without subjecting yourself to all the risks associated with stocks. Keep reading to understand better.

Investing in Stock Market

Whenever people think about investing their money, one of the options that comes to mind are Stocks. You just put your money in stocks, and gain or lose depending on how the stock price goes up or down.

However, stocks are extremely risky. For a normal investor, it is too easy to lose money in stocks, instead of making money.

Money

To start with, you need to know which good stocks to buy are. There is no easy answer to this question. Once you have figured that out, you need to know what the right price to buy those stocks at is. And once that has also been done, you need to know when you should sell the stocks to make some money.

The people who normally make money in stock markets are the ones who have lot of knowledge about stocks. But because a normal investor does not have time to get all that knowledge, there is a lot of probability of losing money.

Is there a way to invest in stock markets without a need to learn about it?

Wouldn’t it have been great if a normal investor could invest money in stock markets by utilizing knowledge of someone who is expert in stocks?

That’s exactly what Mutual funds do.

What is a Mutual Fund?

Mutual funds are a pool of money that is funded by normal investors like you. That pool of money is managed by a financial expert that has the experience of investing in various types’ financial elements such as stocks, bonds, money market, gold and other physical objects. This financial expert is known as a fund manager. The fund manager is responsible for investing the monies of investors in the right way and channel. And any profit and loss that he makes is distributed among the investors of the fund.

Let’s take an example to understand better. Let’s say that you and I want to invest money in stock markets. But instead of directly buying stocks, we decide to go via the route of mutual funds. Let’s assume you put $200 in mutual funds, and I put $100. So, total mutual fund size is $300.

Suppose, the fund manager invests the money in two stocks. He investments $150 in each of the stock. After 6 months, let’s assume that value of first stock increases to $250, while value of second stock comes down to $100. At this point, our total value of investment has become $350. So, we have made $50 profit on our total investment.

At this point, we can choose to withdraw (redeem) money from the mutual fund, and we will split the profits on the basis of our investment value. So, you will get two thirds of the profit, while I will get remaining one third.

Are Mutual Funds really that simple?

The above is a very simplistic explanation of what mutual funds are. In real life, there are typically hundreds of thousands of investors in a fund; the fund size varies from a few million dollars, to a few billion dollars. And the fund manager is typically a team of professionals who do all the research in the stock market, and buy or sell stocks with our money, and pass on the profit and loss to us.

There are two takeaways about mutual funds from the discussion above:

  1. A mutual fund normally invests in multiple stocks. This ensures that there is less risk, as compared to investing in just one stock.
  2. Most importantly – a mutual fund is managed by one or more financial experta who have lot of knowledge about stocks, and are better positioned to invest money on our behalf.

What Next?

This article was aimed at explaining in simple terms what is a mutual fund. In our second article, we will stick to this topic, and will try to give a more practical view of mutual funds. And in the future articles, we will go into even more depths about mutual funds, so that you get all the knowledge you need to invest in this exciting investment vehicle.