Mutual Funds as an Investment

For most people, investing in securities is done through mutual funds. A simple definition of a mutual fund is investors pooling their money to invest stocks, bonds and other accounts. There are several advantages to investing through mutual funds, but the two most important advantages are diversification and professional management.

Mutual funds allow investors to cut down on the risks associated with investing in securities by diversifying investments. Because your money is combined with a large number of other investors' funds, you have the ability to invest in a huge range of securities. Many of the investments would be unavailable to you otherwise because the minimum cost of investing would be too high for an individual investor.

Another reason mutual funds make diversification possible is that they are easy and inexpensive to buy into, and often do not charge fees and commissions for reinvesting dividends and gains or for transferring investments within a mutual fund. While not every fund will be diversified as some concentrate on specific assets, you can still diversify by allocating your investments across different funds.

Tip This is a good time to remind you how important it is to diversify the investment vehicles in your portfolio of holdings. Even if your age and stage of life and your personal risk tolerance is at a level where you are willing to take chances for a bigger return on your investments, no one can afford to lose it all. Therefore, even when a particular security is riding high, resist the urge to put all your dollars there. It's just too risky.

With diversification comes the added problem of managing all the different types of investments you need to meet your goals. Even if it is your full-time job, actively managing a diversified portfolio is difficult at best. By investing in mutual funds, you have the services of financial professionals who use information (which you may not even be privy to) to make decisions that further a mutual fund's objective.

Mutual fund investment objectives. All mutual funds have investment objectives, and they are similar to the objectives of most investments--namely growth or income. And just like other investments, the two categories are not mutually exclusive, however most funds are likely to focus heavily on one or the other. Each fund's objective is achieved by investing in the types of securities (for example, corporate bonds, treasuries and stocks) that enable it to produce the growth or income results it's aiming for. You can find out about a fund's investment objectives through its prospectus.

Mutual funds invest in various sizes of security categories as well. By size we mean large or small companies. The size of a company is based on its total market value or market capitalization, which is determined by taking a company's number of outstanding shares in a stock multiplied by its current stock price. This makes it possible for investors to take diversification to another level by not only buying different types of funds, but investing in different size companies as well.

The following is a list of the terms used to define the size of a company and what the terms mean. While the definitions are not set in stone, the list below will give you a good idea of what size assets your fund is investing in:

• Giant caps. This term describes companies with a total market value of more than $40 billion.
• Large caps. This term describes companies with a total market value of more than $10 billion and less than $40 billion.
• Mid caps. This term describes companies with a total market value of more than $1.5 billion and less than $10 billion.
• Small caps. This term describes companies with a total market value of more than $250 million and less than $1.5 billion.
• Micro caps. This term describes companies with a total market value of less than $250 million.

Keep in mind that some mutual funds invest in certain types of securities no matter what their size.

Tax implications. The tax ramifications of buying, selling and reinvesting in mutual funds vary according to the type of fund you invest in, as well as your personal tax situation, including the state that you live in.

Types of mutual funds. In this section we discuss the different types of mutual funds. Also included is a discussion of how to pick among the mutual funds available.