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What are funds?

Key takeaways

  • Investment funds let you pool your money with other investors to buy more kinds of investments than you could on your own.
  • This can help make diversification easier, though you may still need a mix of funds targeting different parts of the market to be truly diversified.
  • Each investment fund has its own objectives, investment strategies, expenses, and risks, so it's important to select funds that match your objectives, risk tolerance, and time horizon.

The playlist of the investment world, funds can give you easy access to a precrafted greatest hits of investments. Here's everything you need to know about different types of funds.

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Fund definition

A fund is simply a collection of money earmarked for a specific goal. Even if you've never invested a dollar before, you're probably familiar with the concept: You might have a jar where you stash a rainy-day fund or a separate savings account where you're building a fund to replace your roof or upgrade your computer.

What's key in any case is that the dollars you save have a clear purpose. When that purpose is potentially growing more money, many people turn to a particular type of fund: the investment fund.

How does a fund work?

Investment funds provide investors with a professionally managed portfolio of investments that may help investors grow their money over time. They're often started when investors pool their money together to buy more kinds of investments than they could on their own. The investors then receive a number of shares in the fund reflecting how much they contributed. The shares' value may go up and down based on a variety of factors, including the behavior of other shareholders and the value of the investments in the fund. Similar to other investments, shares of the investment fund can be redeemed for cash by the investor.

Fund components can include a range of investments but are generally stocks and bonds.

Types of funds

There are many different types of investment funds, but some of the most common include:

Traditional mutual funds One of the original types of funds the average investor could invest in, traditional mutual funds let you buy shares of a portfolio of investments, which typically contains stocks, bonds, or a mix of both. Many traditional mutual funds are actively managed, meaning professional portfolio managers research and carefully select all of the investments and may adjust fund holdings in response to real-time trends or events.

Some, however, are managed passively: A portfolio manager simply picks investments based on what is tracked in a benchmark index, such as the S&P 500®,1 a grouping of 500 of the biggest companies in America. Passively managed funds don't normally change their holdings unless the components of the index itself change. Notably, traditional mutual funds trade only once per day, after trading on the major stock exchanges has stopped.

Exchange-traded funds (ETFs) By and large, ETFs are similar to traditional mutual funds. Each lets you buy shares that provide exposure to a diversified mix of primarily stocks and bonds. Like traditional mutual funds, ETFs can be actively or passively managed. One of the differences is that unlike traditional mutual funds, ETFs trade throughout the day like stocks.

Read more: Mutual funds vs. ETFs: Which is right for you?

Index funds Index funds are passively managed ETFs or traditional mutual funds that simply seek to replicate the performance of major stock market indexes. In addition to the S&P 500®, common indexes include the Dow Jones Industrial Average®,2 Nasdaq Composite®,3 and Russell 2000®.4 Index funds may be aligned to the US stock market at large, specific sectors of the stock market, stocks in different countries, and even bond indexes.

Target date and target allocation funds As their name implies, target date and target allocation funds are mutual funds that have a target in mind.

Target date funds provide a single-fund option, typically for retirement investing or college saving. You simply pick a fund whose target year matches when you want to retire or when you expect your student to begin college and contribute money to it. Then the fund manager updates the fund's asset allocation over time so that they're more aggressive during accumulation years and more conservative when the fund reaches its target date and beyond.

Target allocation funds, meanwhile, strive to keep a certain percentage mix of different investments, such as 80% stocks and 20% bonds. They shift their holdings based on market conditions to keep the fund's target split.

Advantages of funds

Convenience With investment funds, you don't have to worry about conducting extensive, granular investment-level research yourself or choosing the most opportune time to buy shares of a particular company. Instead, you're turning to the expertise of fund management professionals—or even simply the market itself, in the case of index funds. What's more, products such as target date funds allow you to easily invest in a whole professionally managed portfolio of investments in one place.

Diversification When you invest in individual stocks, you concentrate your dollars in a handful of companies, which can raise the risk that you lose the money you invest. By buying into a fund, you're spreading your investments across tens or perhaps hundreds of stocks, bonds, or other securities. This may lower the risk that any poor-performing investment brings down your entire portfolio's value.

The bottom line on funds

While buying funds may make investing safer and easier, you still have to do your due diligence: Each fund has its own set of objectives, investment strategies, expenses, and risks. You'll want to make sure the funds you select align with your financial goals, willingness to take on risk, and investing timeline.

Take the first step toward investing

To get started, open a brokerage account.

More to explore

1. 

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.
2. Dow Jones Industrial Average, published by Dow Jones & Company, is a price–weighted index that serves as a measure of the entire US market. The index comprises 30 actively traded stocks, covering such diverse industries as financial services, retail, entertainment, and consumer goods. 3. Nasdaq Composite Index is a market capitalization–weighted index that is designed to represent the performance of NASDAQ stocks. 4. Russell 2000 Index is a market capitalization–weighted index designed to measure the performance of the small-cap segment of the US equity market. It includes approximately 2,000 of the smallest securities in the Russell 3000 Index.

Investing involves risk, including risk of loss.

Past performance is no guarantee of future results.

Indexes are unmanaged. It is not possible to invest directly in an index.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility, as well as to the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value in the case of exchange-traded notes). The degree of liquidity can vary significantly from one ETP to another and losses may be magnified if no liquid market exists for the ETP's shares when attempting to sell them. Each ETP has a unique risk profile, detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses.

Diversification does not ensure a profit or guarantee against loss.

Target Date Funds are an asset mix of stocks, bonds and other investments that automatically becomes more conservative as the fund approaches its target retirement date and beyond. Principal invested is not guaranteed.

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