Mutual Fund
Definition
A pooled investment vehicle managed by a professional fund manager that buys a portfolio of stocks, bonds, or other securities on behalf of investors who purchase fund shares.
A mutual fund pools money from many investors to buy a diversified portfolio of securities. Professional fund managers make the investment decisions — selecting which stocks to buy and sell, when to trade, and how to allocate across sectors and asset classes.
Mutual funds come in several categories: equity funds (stocks), bond funds (fixed income), balanced funds (stocks and bonds), money market funds (short-term debt), sector funds (technology, healthcare), and international funds. Within each category, funds range from passive index tracking to aggressive active management.
The key metrics for evaluating mutual funds include: expense ratio (annual fee as a percentage of assets), historical performance relative to benchmark, turnover ratio (how frequently the fund trades), fund manager tenure, and Morningstar rating. Lower expense ratios strongly correlate with better long-term performance.
Unlike ETFs, mutual funds are priced once daily at their net asset value (NAV) after market close. You submit buy or sell orders during the day, but they execute at the end-of-day price. Mutual funds also cannot be margined, short sold, or traded with limit orders.
One significant disadvantage of many mutual funds is capital gains distributions. When the fund manager sells profitable positions, those gains pass through to all shareholders as taxable distributions — even if you didn't sell your fund shares. This makes mutual funds less tax-efficient than ETFs in taxable accounts.
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Frequently Asked Questions
Should I choose mutual funds or ETFs?
For most investors, ETFs are preferable due to lower fees, better tax efficiency, and trading flexibility. Mutual funds may be better in employer retirement plans (where ETFs aren't available) or for automatic investing at specific dollar amounts without fractional share support.
What's a good expense ratio for a mutual fund?
For index mutual funds, aim for 0.10% or less (Vanguard, Fidelity, and Schwab offer funds at 0.015-0.04%). For actively managed funds, below 0.50% is good, though most charge 0.60-1.50%. Every 0.50% in fees can cost $100,000+ over a 30-year investment period.