What is a mutual fund?

There are an increasing number of options available for investors.However because of the ease many people choose mutual funds for their primary investing vehicle. There are many benefits to mutual funds which include: professional management, diversification, convenience and liquidity. However it is important to understand that as with all investments, mutual funds are not risk free. It is essential that you make an informed investment decision and choose a mutual fund which is right for you depending on your goals, investment time frame and risk tolerance. But if you are new to the investing world this can be difficult to understand.Knowing what a mutual fund is and what it can do is the first step. Here is what you need to know-

A mutual fund is an investment vehicle that pools the money of many investors. The fund's manager then uses the money collected to purchase securities such as stocks and bonds. The securities that are purchased are referred to as the fund's portfolio. When you give your money to a mutual fund, you will then receive shares of the fund in return. Each share represents an interest in the fund's portfolio. It is important to understand that the value of your mutual fund shares will rise and fall depending upon the performance of the securities that are in the portfolio. Just like a shareholder in a corporation, you will receive a proportional share of income and interest that is generated by the portfolio. You can receive these distributions either in cash or as additional shares of the fund. In addition as a shareholder, you also have certain shareholder voting rights.

A mutual fund's portfolio is most often managed by a professional money manager. The manager's primary focus is to choose securities that are best suited for the portfolio. It is crucial to understand however, that even a professional money manager cannot insure against a loss of principal. The mutual fund manager will invest in many different securities and this diversification of portfolio assets means that you as an investor have not pinned all your hopes on just one company's success. Also, because the portfolio holds many different securities, the negative impact that any one company may have on the fund is diminished. You should understand that while diversification is a benefit of mutual fund investing, a mutual fund is still impacted, either favorably or unfavorably, by the ups and downs of the market in general.

By and large mutual funds provide a relatively easy way to invest. Keep in mind that most mutual funds (outside of those offered by employers) have a minimum investment of $1000. Another great benefit is that a mutual fund stands ready to buy back, or redeem, your shares at any time. This liquidity for your investment allows you to get your money when needed. There is no guarantee, however, that your shares at the time of redemption will not have decreased in value so like with any investment timing is still crucial.

It is crucial that you always balance the risk with your investment goals.You should never let anyone tell you that mutual funds are free from risk. It is important to understand that while risks vary depending on the fund, the potential danger is the same - loss of principal and income. You are the only who can determine your own risk tolerance level. This determination should be made with your investment goals in mind. While a mutual fund can provide a well thought investment opportunity it is not for every investor. You should always refer to the fund's prospectus to determine the risks associated with a fund.