Mutual funds are an easy, convenient way to invest, without having to worry about choosing individual stocks. A mutual fund can be defined as a single portfolio of stocks, bonds, and/or cash managed by an investment company on behalf of many investors. The investment company manages the fund, and sells shares in the fund to individual investors. When one invests in a mutual fund, they become a part-owner of a large investment portfolio, along with all the other shareholders of the fund. The fund manager invests the contributions when shares are purchased, along with money from the other shareholders. Every day, the fund manager counts up the value of all the fund's holdings, figures out how many shares have been purchased by shareholders, and then calculates the net asset value(NAV) of the mutual fund, which is the price of a single share of the fund on that day. If the fund manager is doing a good job, the NAV of the fund will usually get bigger and the shares will be worth more.
There are a couple of ways that a mutual fund can make money in its portfolio. A fund can receive dividends from the stocks that it owns. Also, the fund might have money in the bank that earns interest, or it might receive interest payments from bonds that it owns. At the end of the year, a fund makes another kind of distribution, this time from the profits they might make by selling stocks or bonds that have gone up in price. Unfortunately, funds don't always make money. For example, the fund manager could have made some investments that didn't work out, sold some investments for less than the original purchase price, and there may be some capital losses.
Most mutual funds invest in stocks, and these are called "equity funds." Some funds specialize in investing in large-cap stocks, others in small-cap stocks, and mid-cap stocks. Large-cap stocks have market caps of billions of dollars, and are the best-known companies in the U.S. Small-cap stocks are worth several hundred million dollars, and are newer, up-and-coming firms. Mid-caps are somewhere in between. There are also bond funds that purchase bonds issued by corporations, municipal governments, or the federal government agencies. You can invest in tax-free bond funds, just as you can buy tax-free bonds, and the interest you earn is exempt from federal and perhaps state and local income taxes. Mutual funds that specialize in securities outside the U.S are known as international funds or global funds. These funds can also specialize in bonds, stocks, or some mix of the two. An international fund can also specialize in a particular country or region of the world, such as the Pacific Rim, Latin America, or Germany.
Equity-fund managers usually use one of three particular styles of stock picking when they make investment decisions for their portfolios. First there is value, where a fund manager uses a value approach search for stocks that are...