A mutual fund is a collection of financial securities, pooled into a common portfolio and sold in equal shares to the public. A mutual fund is also known as an investment company. The financial securities in the portfolio may be stocks, bonds or other types of securities. The mutual fund sells or buys back shares to/from the public based on the total value of all the securities in its portfolio.

Most mutual funds are 'open-end' funds. This means they will buy back or sell additional shares each day - there is not a fixed number of shares outstanding. The price per share is the total market value of all the fund’s assets (securities owned plus cash), less any liabilities (expenses), divided by the number of shares outstanding. This is also called the net asset value, or NAV. The value of each share is the same for all investors, large and small.

Advantages a mutual fund offers:

• Diversification.
• Professional management.
• Equal treatment for both large and small investors(1).
• Easy to buy or sell.
• Automatic reinvestment of the fund’s income and profits.
• Automatic withdrawal for monthly income.

Currently, there are more than 10,000 mutual funds and these funds can have varying investment styles and objectives. For example, a fund may focus on large-cap stocks or investment-grade bonds. With so many funds available, investors can easily find a fund that will match their specific investment style and objective.

Examples of different mutual fund categories and styles:

• Large-cap stocks.
• Mid-cap stocks.
• Small-cap stocks.
• Multi-cap - a blend of stock capitalization sizes.
• US Government bonds.
• Investment-grade bonds.
• Intermediate-term investment-grade bonds.
• Short-term bonds.
• High-yield bonds (junk bonds).
• Balanced - a portfolio of both stocks and bonds.
• International equities - foreign stocks.
• International bonds - foreign bonds.
• Sector - a specific sector of the economy such as - technology, financial, energy...
• Index - the fund matches a market index such as the S&P 500 or Russell 2000.
• Money Market - short-term cash equivalent.

Fund Management

Mutual funds are either actively managed or designed to match an index. In a managed fund, the manager makes investment decisions regarding the suitability and potential of each security in the portfolio. The manager buys and sells securities for the portfolio as deemed appropriate.

In an Index fund, the manager will maintain the portfolio so that it matches the security composition of an established index. The manager does not evaluate the underlying investments.

Expense Ratio

When selecting a mutual fund, investors should be aware of the expense ratio. This is the operating cost to the investor to own the fund. Operating expenses are charged annually by the management company and reduce the return to the investor. These costs include management, custodial, record keeping, marketing, and accounting expenses. Some managed mutual funds may have expense ratios of 1% or higher, while index funds can be .5% or lower - many under .20%.

12b-1 Fee

A few mutual funds impose a 12b-1 fee. This optional fee is charged for marketing expenses of the fund.

Commission - sales charge

Mutual funds may come with a sales charge - a commission paid to the broker when you buy the fund. Sales charges are detailed in the fund’s prospectus and can vary depending upon the amount invested.

Most mutual funds today are known as "no-load" funds. That means they do not charge a commission when you purchase the fund. A few "no-load" funds may have redemption fees - charges imposed when you sell your shares.

When you purchase or sell some “no-load” funds through a broker, the broker may charge a transaction fee for processing the trade.

Also, review Exchange Traded Funds (ETFs) and Chapter 8 Investing for Retirement - Surviving a Financial Tsunami.

(1) Initial sales charges may vary based upon the amount of the investment.