So you understand what stocks and bonds are… for the most part.
That’s okay. It’s going to take a few tries to get that “Oh! That makes sense!” moment. Stick with it, and let’s add on to things a little bit.
A fund is a pool of money that is used to invest in different things. It can be a group of friends that each chip in a few hundred dollars to buy stocks together, or a group of investment companies that gathers up billions of dollars to invest in everything under the sun.
The Four Fund Families
There are four main types of funds that people often talk about – mutual funds, exchange traded funds (ETFs), index funds, and hedge funds. For this post, we’re going to focus on mutual funds, ETFs, and index funds. We’ll talk about hedge funds later.
One thing that all four fund types have in common is that they seek to reduce the risk of losses to their investors through diversification. Simply put, diversification means that instead of putting all of your eggs in one basket, you spread them into many baskets. If, for instance, you put all of your money into one company’s stock, you can lose everything if that company does poorly or goes under. However, if you spread your money out into many different companies, it lessens the impact of one company’s performance.
Mutual funds
Investopedia.com defines a mutual fund as “a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.”
In English? A mutual fund is a pool of money that is gathered up and managed by a professional manager in return for a fee. Depending on the mutual fund type and its stated goals, it may invest in stocks, bonds, or other types of things with the goal of making money for its investors. You can find out more about the fund by reading its prospectus.
Mutual fund shares are generally bought or sold at the end of each trading day and use the Net Asset Value (NAV, which is value of the fund’s investments divided by the number of outstanding shares) to determine trade prices.
*For more on Mutual Funds, check out investopedia.com.*
ETFs
An ETF is fairly similar to a mutual fund in that both types of fund allow investors to pool money together to purchase investments. The main difference is that unlike mutual funds, ETFs can be traded on a stock exchange, meaning that they can be bought and sold at any point during normal trading hours, and their prices can fluctuate. ETFs also typically have lower fees than mutual funds.
*For more on, ETFs check out investopedia.com.*
Index Funds
An index fund is a type of mutual fund or ETF that is designed to track the components of a financial index, which is a hypothetical group of investments that is based on a specific set of rules and used to track the movements of larger sectors of the economy. Well-known examples of indices include the S&P 500, which is made up of 500 of the largest publicly-traded US companies, or the Dow Jones Industrial Average (DJIA/The Dow). Index funds follow the specific set of rules that are laid out in the construction of the index, so instead of a manager who is trying to find the best investments, the fund is constructed according to those rules. Because of this, the fees for index funds are typically much lower than funds that have an active manager running them.
*For more on, Index Funds check out investopedia.com*
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