What is a Mutual Fund?

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Instead of investing in stocks, bonds, or securities ourselves and trying to diversify and picking a few of this stock and a few of that stock and mixing it up and creating a portfolio. There is something called a mutual fund in the US or unit trust in the UK, which basically allows us to achieve that objective and achieve it more efficiently and slightly easier.

Mutual fund that is the topic of this particular section. A mutual fund is a pool of money that is contributed by many smaller investors, sure there are some large ones but more than. Typically more than one investor and most often thousands or even hundreds of thousands of investors that contribute some money to create a large pool of assets that are then managed by an investment professional. Who is also known as the portfolio manager or mutual fund manager -who basically makes the investment decisions on behalf of each of the investors in that fund and those therefore who have contributed money to the fund.

Mutual fund tend to have guidelines by which they invest and they tend to have a benchmark against which they are measured. So for example a mutual fund might be a US stock market mutual fund or a UK stock mutual fund or a European equity mutual fund. And those guidelines decide and define what is the portfolio manager invests in and how he is measured and what his benchmark is. So for example a US stock market might invest in the 500 most widely held companies in the US and might have it as a benchmark the SNP 500 index. So it typically holds the stocks in a very close proportion to the stocks as they are in that index the SNP 500 index. What that means is the mutual fund manager then would make decisions whether to over or under weigh certain stocks within that index, maybe even buy a few that aren't in that index. But overall he wouldn't deviate too far from the index because then he would have too much, what's known as tracking error and the risk of having a performance that is close to the benchmark get increasingly high. So if you pick stocks that are around the benchmark over weigh does he likes and under weigh those he doesn't like, with a view to beating the performance of the benchmark. The benchmark then, for example could be SNP 500, if it is up 10% then the mutual fund manager would have done a great job if he gets performance of more than 10%. And the investors in the mutual fund can typically own units or shares in that mutual fund and they’ll benefit from that performance as well.

So what you, what are the benefits of mutual funds? Well they tend to own a lot of stocks so they provide diversification and it will be difficult for us with $1000 to own all the stocks that a mutual fund does. When we could own part of a mutual fund and then get all the diversification with all of the money that is then pooled into a larger sum and buys hundreds of stocks potentially. We could never buy hundreds of stocks with $1000. We have an investment professional that takes decisions. We have a better risk management and risk control system, we can basically capture the performance, it's something is very close to the performance of a particular index or market. The mutual funds tend to be a very good alternative for many investors and form the basis for many people to have their equity holdings or their bond holdings through mutual funds. And it's particularly for those advantages that that is the case.