Mutual Funds (Part 1)

Introduction

What is a mutual fund? A mutual fund is a collection of securities bought with money pooled together from many investors. The collection is then sold as one package. If this sounds familiar to you, then good for you! Mutual funds are, in many ways, similar to ETFs. If you don’t know what an ETF is, check out my article on them here.

How to Trade

Mutual funds trade quite differently than regular stocks and ETFs. Instead of being available to buy or sell at any time during trading hours (9:30 am - 4 pm EST), shares of mutual funds are only available at the end of the trading day.

Also, unlike stocks and ETFs, the price per share of mutual funds isn’t based on demand. It is based on something called the net asset value, commonly abbreviated NAV. The net asset value is calculated by adding all the assets in the fund, subtracting the total liabilities, and then dividing that by the total number of shares outstanding. This number represents the value of each individual share, and this is the price that you pay when you buy into a mutual fund and the price that you can sell it at.

Risk

Mutual funds are popular because they are much safer than regular stocks. The reason for this is because of a concept called portfolio diversification. If you don’t know what that is, it's basically when a portfolio has many different stocks from different industries. For more information, you can read my article on diversification here.

By definition, a mutual fund is pre-diversified, since it is a collection of many securities. Therefore, its risk is much smaller since if one stock does poorly, it can be balanced out by good performances from other stocks in the fund. Thus, mutual funds are good investments for people who want good returns but don’t want the risk that stocks have.