What is a Mutual Fund? Basic Concept Defined

In general, a "Mutual Fund" can be defined as a large pool of money used by a "Mutual Fund Company" to purchase a wide range of investment products ( Usually Stocks & Bonds or other financial instruments) on behalf of it's participants. There are several different kinds of funds that purchase a wide range of securities such as stocks, bonds, options, derivatives, and IPO's. The combination or investment weightings of the preceding are almost infinite. Some funds will "Side" with the "Financial Markets" and should eventually prosper if the indices rise, and others will "Side" against the markets and potentially yield positive results if the markets fail. When choosing a fund, participation depends on which direction the investor thinks the markets will go in the long term, UP or DOWN.

It's estimated that the first mutual fund was created in the 1920's however they really didn't enter the mainstream investment community until roughly the late 1970's. The original concept was designed and implemented as an easy way for people who may not be financially savvy, to become engaged and ultimately involved in the fast paced potentially high reward Stock & Bond Markets. Very little if any knowledge in complex Wall Street activities and strategies are required as long as your faith in those who manage the fund is unwavering. Depending on which mutual you choose to invest in, the day to day price fluctuations that affect the account balance can test your nerves at times, sometimes to the limit, so it's always a good idea to discuss every aspect with a Financial Advisor prior to making a deposit.

Now let's take a look at the general concept and basics of what a mutual fund is. The following is a short answer to a very long and sometimes complex question, but it should provide a good foundation of understanding from which to build upon.

If you strip away all the bells & whistles and focus on the underlying theme, the basic concept is really not that difficult to understand. The following is how I personally define a Mutual Fund and if you reference other sources I think you'll come up with something very similar.

• A "Mutual Fund" is a large collective pool of money deposited by individual investors or institutions which is used by a Mutual Fund Company to purchase and or sell equity, debt, and other securities on your behalf with the intent to provide the best possible return. -

The above definition cuts right through to the basic concept, however certain aspects are a little more complicated especially when you address "Tax Considerations", "Types of Investments", "Strategies" etc.

• Although many other types of securities can be bought & sold, the above list includes some of the most popular -

Automatic Diversification

One of the main benefits of investing in a Mutual Fund verses individual securities is automatic diversification. At any given time, the same fund can own several different stocks or bonds or combination of the two. 30 , 40, 50, or even 100+ distinct issues can and usually are held in a typical fund portfolio.

How does this benefit the participant? The main advantage of diversification is to provide a hedge, which means if one or two or more securities decline in market value it should have minimal effect on the overall fund performance due to the fact that other securities might rise in value resulting in a mitigation of total lost value ( Unless of course the major indices experience a more significant "Correction" ). One way to put this in perspective is the following, If you own a 100 shares of single stock what happens if the price declines without a hedge? your $20 stock is worth $18 and your balance is $200 less than what it was before. Now in contrast, if we realized the same result in a Mutual Fund, another stock within the portfolio might go UP from $18 to $20, hence canceling out the overall negative effect of the stock that declined in value.

Remember the saying " Don't put all your eggs in one basket? There's no better example of "Not putting all your eggs in one basket" than a Mutual Fund. Most funds will never buy and hold one single security, they will always purchase a wide variety or "Diversify".

Money Management

When you invest in a Mutual Fund essentially your hiring a Money Manager(s) to over see, research, and make important investment decisions on your behalf. The fund may have one or more professionals working day and night to try and implement the best possible strategy which will hopefully yield the highest return. Just think of it this way, 50,000 people toss $1000 each into a wheel barrel, then a Money Manager pushes it to his/her office and begins to slowly divide the funds into several piles to purchase a diversified selection of mainly stocks and or bonds. Pretty simple concept but essentially that's the basic principle, just remove the wheel barrel and replace it with a trust account and there you have it.

There are many important considerations but one of the main benefits of investing in a Mutual Fund is the convenience and time saving aspects, you let a professional choose which securities to buy and sell, and he/she monitors the portfolio 24/7 using state of the art technology. In addition, the fund Manager may have access to unique timely data that the individual investor may not have which in turn can lead to more efficient trading. If your not in the position to research & monitor investments in a personal portfolio, hiring a Mutual Fund Manager can be a big time saver.

Final Note From an Investor's Point of View:

Mutual Funds can be an excellent way to participate in stock & bond markets mainly due to the inherent nature of immediate "Diversification" which allows you the opportunity to own a large basket consisting of several different issues for considerably less money than you would need to purchase each individual stock or bond separately on your own.

• Mutual Funds invest in securities listed on all exchanges including the NYSE, NASDAQ, AMEX, and even "Penny" or "Pink Sheet" issues. The level of risk varies dramatically between funds so pick and choose wisely together with an Advisor. -

If your interested in a Wall Street type of investment but are not up to speed with financial terms, strategies, or investments your certainly not alone, the vast majority are probably in the same situation, and a mutual fund which essentially does all the work for you might be the way to go until you become familiar with the incredibly complex world of Stocks & Bonds. But remember, always check with your Financial Advisor before investing