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What if you could invest in hundreds of companies all at once, without ever picking a single stock yourself?
Well, with mutual funds, you can do just that.
They make diversification easy by letting you spread your money across many investments just by buying a single fund. So, what are mutual funds? Here’s how they work: a mutual fund gathers money from many investors into one big pool. Then, with all that money, the fund manager may buy stocks, bonds, or other investments, depending on the fund’s investment objective.
And it’s a big job for that manager because they’re responsible for that fund’s performance. If the fund does well, everyone gets a piece of the profits. But if it doesn’t, everyone shares in the losses.
Here’s our investment professional Stephanie to walk you through a hypothetical example.
Now let’s say the fund currently holds about $560 million in investments and has a Net Asset Value or NAV of $25 per share.
The NAV represents the fund’s per-share value, and unlike a stock’s price which constantly changes throughout the day, a mutual fund's NAV is calculated only once a day, after the market closes.
This is done by adding up everything the fund owns, subtracting what it owes, and dividing it by the total number of shares.
Now in our hypothetical example, let’s say 1,000 new investors each put in $5,000 dollars. That would add $5 million to the fund.
And since $5,000 divided by the $25 NAV equals 200, the fund would create 200 new shares for each investor.
This is where the fund manager comes in. Their job is to take that new 5 million dollars and invest in assets or companies that match the fund’s strategy. Now performance can vary from year to year but in this scenario, let’s say the manager has delivered a positive performance because the stocks they’ve picked have gone up in value. We’ll say the fund grows to $644 million dollars, a 15 percent increase. That pushes the NAV from $25 dollars per share to $28.75 per share.
And that means our investors are experiencing gains too, with everyone’s initial $5,000 investment growing by $750. And if they continue to stay invested, their gains can potentially grow even further through the power of compounding.
That was a positive example but it's important to remember that this isn’t always the case, because investing can have real risks. For instance, if the fund dropped by 15%, the NAV would fall from $25 dollars to $21.25 and that same $5,000 investment would decrease by $750.
Now that we’ve covered the basics, Dessa will dive a little bit deeper into the types of mutual funds.
There are A LOT of different mutual funds, and they all have different strategies. Most are professionally managed, but what the manager actually does depends on the fund’s overall approach.
With an active mutual fund, like Theta Blue Chip Value Fund, the manager takes on a more hands-on role.
Their job is to stay on top of the market, researching companies, analyzing trends, and deciding which investments to buy, hold, or sell. And the goal? To do better than an index or benchmark like the S&P 500 Index, which tracks the performance of 500 of the largest U.S companies.
Some investors choose active funds because they want a professional to make those types of decisions for them, though this expertise usually comes with a higher management cost, called an expense ratio.
With passive mutual funds on the other hand, the fund manager is more hands-off and doesn’t just pick any individual investment.
Instead, the fund is designed to mirror an index like the S&P 500 Index, which you can’t invest in directly. The manager’s job is to simply keep the fund tracking the same mix of companies as the index. So, if the index changes, the fund changes as well.
Some investors prefer passive funds because they usually have lower management costs and provide exposure to widely followed indexes.
Another type of mutual fund is a money market fund.
Money market funds are low-risk, high-liquidity mutual funds that invest in short-term, high-quality debt securities like U.S. Treasury bills . They aim to provide stable returns for cash, often paying higher interest than traditional bank savings accounts.
And because they invest in very short-term, high-quality assets, the trade-off is that returns may not always keep up with inflation. Even so, the focus stays the same: stability.
And while money market funds don’t come with the same government-backed insurance that bank accounts have, they do include other types of protections for investors.
Let’s talk about target date funds. These are designed for a specific year in the future, usually when you want to retire. They typically start with more aggressive investments then gradually shift toward more conversative ones as that date approaches. Though investing in a target date fund doesn’t guarantee the principal of the investment.
There are many other mutual funds out there, so if you want to learn more, check out the link in the description.
Now you already know that diversification is a benefit of mutual funds. So let’s talk about a few other advantages.
First, most mutual funds let you start investing with a low dollar amount, or sometimes no minimums at all. This allows you to gain exposure to a wide range of investments you might not be able to afford individually.
And even though the fund managers are handling the day-to-day management and investment decisions, you still have a job to do, which is to check in at least once a year or when life events happen, to make sure it still fits your timeline, risk level, and overall financial situation.
Now, all that convenience does come with a tradeoff…mutual funds charge management fees known as expense ratios, which are usually below 1% but can sometimes be higher.
Expense ratios cover things like operating costs, research, administrative expenses, and more. After all, someone has to pay the manager for doing all that managing, right? These fees can vary widely depending on the fund.
Let’s go back to our example and assume it has a point eight percent (0.80%) expense ratio. Now you don’t pay this fee out of pocket, the fund deducts it from its assets. That means about $8 is taken from the fund each year for every $1,000 invested, which then reduces the fund’s return to you.
So since our investors each put in $5,000 dollars, their share of the expenses would come to about $40 for the year.
Now something else to consider with mutual funds is that you can place an order any time of the day, but they only trade once per day, after the market closes, at their Net Asset Value. So even if our investors had placed an order for the Theta Blue Chip Value Fund at say 10am, it wouldn’t have gone through until later that day.
You also need to think about taxes. Even if you didn’t sell anything, fund managers buy and sell investments throughout the year which could trigger capital gains distributions that you may end up owing taxes on.
That’s it for mutual funds. I hope you enjoyed this video. There are many other mutual funds out there so if you want to dig a little deeper visit Fidelity.com/Learn
Till next time, investors.