What Are Mutual Funds?

Check the background of investment professionals associated with this site on FINRA'S BrokerCheck.

A mutual fund is a professionally managed investment that allows you to pool your money together with other investors to purchase a collection of stocks, bonds, or other securities that might be difficult to recreate on your own.

The typical private investor may own a few dozen stocks or bonds. But each share of a mutual fund includes holdings across potentially hundreds of investments, not just a single stock or bond. Holdings are assembled to address specific investment strategies such as preservation of capital, growth or income, and may be invested in almost any market from stocks and bonds to real estate or other securities.

How Mutual Funds Work

It's important to note that mutual fund investors own shares of the fund itself--not the individual securities. Mutual fund investors do not have “voting rights” or the ability to influence the investments held in the fund. Instead, each share entitles an investor to share in any gains or losses generated by the fund's investment portfolio.

The price of a mutual fund share, also known as its Net Asset Value (NAV), is calculated by dividing the total value of the fund by the number of outstanding shares less any transaction fees. Prices change based on the value of the securities in the fund as recorded at the end of each business day.

Buying & Selling Shares

Investors buy and sell mutual fund shares directly from the fund or through a brokerage account, rather than individually from other investors. Shares can be "redeemed" or sold back to the fund at any time. However, mutual fund companies and brokerage firms may charge fees, commissions or other charges for redeeming shares which lowers your total profit/loss from the sale.

Even minor fees add up. A difference of just 1% in operating expenses, may lead to large differences in returns, especially over long periods of time. For example, if you invested $10,000 at a 10% annual rate of return with annual operating expenses of 1.5% of principal, after 20 years your investment would yield $49,725. If, however, annual operating expenses were only 0.5% of principal, that same $10,000 would yield $60,858.*

Effect of Differences in Mutual Fund Fees (0.50% vs. 1.5% Annually)

This is a hypothetical example and is not representative of any specific investment. Your results may vary.

How Mutual Funds Generate a Return

Investors typically earn a return from mutual funds in three ways:

Dividend Payments

Mutual funds generate income from dividends on stock and interest on bonds held in its portfolio. The fund passes along this income to its investors in the form of a distribution. Distributions may come as cash payments or be automatically reinvested to purchase more shares in the fund.

Capital Gains

When a fund sells a security that has increased in value, the profits generated from the sale are called a "capital gain." Mutual funds pass along capital gains as distributions to investors.

Redeeming Shares

If a fund's shares increase in price above what was paid for them, redeeming shares with the fund produces a capital gain for the investor.

When held outside of a retirement account, distributions and capital gains from mutual fund investments are taxable either as investment income or capital gains, which differ from wage-based income. Consider consulting with a tax professional about the implications for your taxes before investing in a mutual fund.

Risks of Mutual Fund Investing

Mutual funds are not guaranteed by the FDIC or any government agency, although they are regulated nationwide by the Securities and Exchange Commission (SEC). If your mutual fund loses value, your investment loses its value as well. All funds are subject to the risk of financial loss regardless of past performance. Just because a fund performed well in prior years does not mean it will continue to do so in the future. Typically, the less stable a fund's past performance the higher your investment risk.

Talk to a Financial Advisor

Financial advisors with BECU Investment Services are here to help. They take the time to get to know you and understand your goals, so they can plan and implement a financial and investment strategy that's best for you. Set up a complimentary consultation or call 206-439-5720.