A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the income it generates.
A mutual fund will provide diversification through the exposure to a multitude of stocks. The reason that is recommended over owning a single stock is that owning an individual stock would carry more risk than a mutual fund. This type of risk is known as unsystematic risk. Unsystematic risk is risk that can be diversified against. For example, by owning just one stock, you would be carrying company risk that may not apply to other companies in the same sector of the market. What if their CEO and executive team leave unexpectedly? What if a natural disaster hits a manufacturing center slowing down production? What if earnings are down because of a defect in a product or a lawsuit? These are just a few examples of the types of things that could happen to one company, but are not likely to happen to ALL companies at once.
Mutual funds may not look flashy, but for many people, they’re an excellent way to achieve financial goals. That’s because mutual funds are professionally managed and offer diversification, which you don’t get when you buy individual stocks.
Professional management matters. When you buy a fund, the fund takes your money and pools it with others’ money into one big pile. The fund manager’s job is to decide which stocks to buy, sell, and hold—while you’re busy at work and raising children. Each manager uses a methodology or discipline to select stocks or bonds. Every day, fund managers and their team of analysts examine the companies they own to see if they still fit their criteria for securities selection.
Mutual funds can be used to meet a variety of financial goals. For example:
- A young investor with a stable income and many years to invest may feel comfortable taking more risk to achieve a greater potential return. They may invest in an equity fund.
- A mid-career investor trying to balance risk and return more moderately could invest in a balanced mutual fund that buy a mix of stocks and bonds.
- An investor approaching retirement might be less comfortable with risk and more interested in fixed income investments. They may invest in a bond fund.
While we know there are a plethora of investment options (individual stocks, ETFs, and closed-end funds, to name a few) a mutual fund can offer a simple, efficient way to invest for retirement, education or other financial goals.
Merit Advisors was founded on a simple and basic principle: Managing risk of loss is critical in order to generate consistent, positive returns over the long-term. We help to ensure you receive the most current and comprehensive guidance and working together, we can help you develop a complete, tailored strategy to help you achieve your financial goals.