What is a mutual fund? Basics, pros and cons

Explore the potential benefits of investing in different types of mutual funds and how this solution may fit into your broader investment strategy.

A shot of an investor’s portfolio on a tablet.

Mutual funds are a type of investment vehicle that pools money from many investors to invest in a variety of asset types. They can help you diversify your portfolio over the long term.

An Ameriprise financial advisor can help you select the appropriate types of mutual funds that align with your financial goals, risk tolerance and time horizon.

Here’s an overview of the basics of investing in mutual funds:

What are mutual funds?

A mutual fund is an investment that pools your money with that of other investors who share similar investment goals. Professional money managers use the pool of money to buy securities that can help achieve the mutual fund's specified objectives.

Mutual funds offer professional management and diversification, but they involve investment risks, including possible loss of principal and fluctuation in value.

Mutual funds infographic

What are the types of mutual funds?

There are a variety of types of mutual funds, which usually fall under one of the following four categories:

  • Equity (stock) funds are invested in corporate stock of publicly traded companies. These funds can be classified based on a variety of components, including company size, industry or sector type, or based on potential growth and value.
  • Bond funds are made up of debt instruments that the government or a corporation issues to investors to raise capital. They often carry less risk than stock funds; however, they may have less potential for growth.
  • Money market funds invest in cash or cash-equivalent short-term debt from entities like the government or corporations. Money market funds are generally considered to be a low-risk investment.
  • Hybrid funds are comprised of at least two or more asset classes — typically a blend of stocks and bonds. One of the most popular forms of hybrid funds are called balanced funds, which typically invest 60% in stocks and 40% in bonds.

Pros and cons of mutual funds

Mutual funds can be an efficient and cost-effective means of investing money; however they also come with risks and tradeoffs. Some pros and cons of mutual funds include:

Potential benefits

Risks and considerations
  • Diversification: When you invest in mutual funds, you can invest in a variety of different types of stocks and bonds from a variety of industries. This typically exposes you to less risk than purchasing individual securities, as one asset’s poor performance may be offset by others performing well.
  • Low barrier to entry: While your investment strategy depends on your fund's rules, you may be able to make smaller contributions that can grow over time.
  • Professional money management: Mutual funds provide professional managment, ongoing supervision of your holdings and diversification within the fund.
  • Liquidity: Mutual funds provide liquidity – and because shares of a mutual fund are priced daily, you always know the value of your investment.
  • Potential for loss: Mutual funds may lose principal and fluctuate in value.
  • Costs: A mutual fund may incur sales charges either upfront or on the back end that are passed on to the investors. Some mutual funds can have high management fees and it's especially important to pay attention to the annual fees charged to invest in a mutual fund, since they can erode your returns.
  • Tax implications: 
    • Dividends and interest payments are generally considered taxable income by the IRS even if you reinvest the money.
    • If you earn a profit from the mutual fund either through the sale of all or some of your shares or if the fund managers sell securities in the fund for a profit, the IRS generally considers your profit a capital gain which is taxable income even if you reinvested the money.

Basics of investing in mutual funds

Understanding a fund’s performance is critical to investing in mutual funds. When comparing different types of mutual funds, review their prospectus to ensure the funds' investment objective and risk level meet your individual investment goals. Consider the following factors:

  • Past performance: While historical performance is not a guarantee of future results, understanding a fund’s previous performance provides valuable context — including its performance during market highs and lows.
  • Turnover ratio: The value of a fund’s trades in a year compared to its total value of assets. For example, if one mutual fund invests in 50 stocks and that year replaces 20 of those, the turnover ratio would be 40%. Funds with higher turnover ratios tend to be more expensive than those with lower turnover rations due to costs accrued when buying and selling stocks.
  • Total return: Total return is a measure of a fund's performance including reinvested dividends and capital appreciation. Listings may be calculated for different time periods — often weekly. Check for the durations being used.
  • Operating fees, sales charges and other expenses: Investors may pay annual operating fees, shareholder fees and other fees and penalties.
    • Expense ratio: Also known as a mutual fund’s annual operating fee, this number can be calculated by dividing a fund’s annual expenses by its average net assets. The higher the expense ratio, the higher the cost to the investor.
    • Shareholder fees or sales charges: These commissions and redemption fees are also known as either a front-end load or a back-end load depending on whether they’re assessed at the time of purchase or the time of sale.
    • Early withdrawal charges: These may be incurred when withdrawing or selling the holding early.

How might mutual funds fit into your portfolio?

An Ameriprise financial advisor can help you determine which type of mutual funds may be appropriate for your investment portfolio, given your financial goals, time horizon, risk tolerance and personal needs.

How might mutual funds fit into my investment portfolio - and support my personal goals? What types of mutual funds would be appropriate for me? What other investment solutions should I consider?

When you’re ready to reach out to an Ameriprise financial advisor for a complimentary initial consultation, consider bringing these questions to your meeting.

When you’re ready to reach out to an Ameriprise financial advisor for a complimentary initial consultation, consider bringing these questions to your meeting.

warning Something went wrong. Do you want to try reloading? Try again
RELATED INFORMATION

Investing in the stock market: Pros, cons and investment options, explained

What to know about bonds and fixed income investing

Asset classes: The building blocks of an investment portfolio

Get personalized investment recommendations to help you reach your goals.

Or, request an appointment online to speak with an advisor. 

 default

At Ameriprise, the financial advice we give each of our clients is personalized, based on your goals and no one else's. 

If you know someone who could benefit from a conversation, please refer me.

Background and qualification information is available at FINRA's BrokerCheck website.

 nextgen2024
This information is being provided only as a general source of information and is not a solicitation to buy or sell any securities, accounts or strategies mentioned. The information is not intended to be used as the primary basis for investment decisions, nor should it be construed as a recommendation or advice designed to meet the particular needs of an individual investor. Please seek the advice of a financial advisor regarding your particular financial situation.
Clients should consider the investment objectives, risks, charges and expenses of a mutual fund carefully before investing. The prospectus contains this and other important information about the funds and should be read carefully before investing.
Ameriprise Financial cannot guarantee future financial results.
Diversification does not assure a profit or protect against loss.
Past performance is not a guarantee of future results.
Ameriprise Financial, Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.
There are risks associated with fixed-income investments, including credit (issuer default) risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.
The initial consultation provides an overview of financial planning concepts.  You will not receive written analysis and/or recommendations.
Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
Securities offered by Ameriprise Financial Services, LLC. Member FINRA and SPIC.