A mutual fund is an open-end professionally managed investment fund that pools money from many investors to purchase securities. Investing in mutual funds offers benefits you won't get from trading individual stocks and bonds on your own. One mutual fund can invest in hundreds—sometimes thousands—of individual securities at once. So if any one security does poorly, the others are there to help offset that risk. You don't have to keep track of every security your mutual fund owns. With a no-load mutual fund, you pay one (hopefully low) expense ratio—instead of racking up the commissions you'd pay when buying and selling individual securities yourself. The fund is managed by experts who take care of that for you.
Active vs. passive mutual funds
A mutual fund's fees and performance will depend on whether it is actively or passively managed.
Passively managed funds invest to align with a specific benchmark. They try to match the performance of a market index (such as the S&P 500), and therefore typically don’t require management by a professional. That translates into lower overhead for the fund, which means passive mutual funds often carry lower fees than actively managed funds.
Here are two types of mutual funds popular for passive investing:
1. Index funds are made up of stocks or bonds that are listed on a particular index, so the risk aims to mirror the risk of that index, as do the returns. If you own an S&P 500 index fund and you hear that the S&P 500 was up 3% for the day, that means your index fund should be up about that much, too.
2. Exchange-traded funds can be traded like individual stocks, but offer the diversification benefits of mutual funds. In many cases, ETFs will have a lower minimum investment than index funds.
Actively managed funds have a professional manager or management team making decisions about how to invest the fund's money. Often, they try to outperform the market or a benchmark index, but studies have shown passive investing strategies often deliver better returns.
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