One of the choices for your retirement savings may be a mutual fund, a pooled investment with a specific objective to help owners reach their own financial goals.
Quick takeaways
When you have retirement savings like an individual retirement account or a 401(k) account, you’ll generally have options for investing your contributions. One such option may be mutual funds. What are mutual funds and how do they work? Here are some insights.
A mutual fund is what’s called a pooled investment; when you invest in one, you’re an owner of the fund. Every mutual fund has a financial goal, such as “income”; that goal helps determine the investments that make up the mutual fund. Mutual fund owners purchase shares of the fund, which is invested in a lot of different things, not just one company.
There are two main types of mutual funds: active and passive.
Active mutual funds employ a professional manager who constantly chooses and adjusts the mix of investments based on the fund’s goal. That manager uses a market index—say, the S&P 500—as a benchmark and sets out to beat that index. Assets in funds may be structured in a couple of ways.
| How active mutual funds are generally invested | |
|---|---|
| Balanced | A mix of stocks and bonds invested to maintain a specific balance or exposure |
| Bond/fixed income | A fixed (and typically minimal) rate of return from interest income and the purchase of undervalued bonds |
| International/global | Invested in companies or bonds outside of the U.S., or a combination of investments both in and outside the U.S. |
| Sector/specialty | Invested in a specific industry or market |
| Short term/fixed income | Often low risk, invested in securities that have a very short-term duration, high-quality debt, or cash equivalents |
| Investment risk adjusted over fund lifecycle (based on a particular target date) | |
| Target risk | Invested for a target level of risk—e.g., conservative, moderate, aggressive |
| U.S. equity/stock | Invested in the stocks of companies |
A passive mutual fund, on the other hand, chooses an existing index and tries to stay keep pace. Because passive funds try to replicate a market index, they are often referred to as just that—an index fund.
If you’re a mutual fund owner, here’s how your investment can generate growth:
- Stocks or bonds that are part of the mutual fund pay out dividends and interest.
- Assets in the fund increase in value, generating capital gains.
- Mutual fund shares you sell have a higher net asset value (see below) than when you bought them for a profit/capital gain.
There are literally thousands of mutual funds in the United States alone, and it can feel overwhelming to sort through choices on your own. A financial professional can help, as can understanding some key mutual fund terms, including:
- Fees and expenses: Mutual funds typically have both an annual fee and fund management costs.
- Minimum investment: Most mutual funds require a minimum dollar amount to invest.
- Net asset value (NAV): A calculation from the fund’s manager, performed at the end of each trading day; it determines the price of mutual fund shares for new investors. NAV = (market value of all shares - fund's liabilities) ÷ number of issued shares
- Portfolio manager: The person or head of a team of people who manages mutual funds.
- Prospectus: A document detailing mutual fund objectives and the investment’s portfolio mix. Every investor must receive a copy of or access to the prospectus as a prospective buyer, investor, or participant.
- Total return: The positive or negative change in the value of a fund over time measured in one-, five-, and 10-year or since inception periods.
What’s included in your retirement savings?
