Mutual Fund Basics

• A mutual fund is an investment vehicle comprised of a pool of funds collected from many investors for investing in securities such as stocks, bond, money market instruments and other assets. Like stocks, mutual funds are highly liquid, meaning that you can easily convert your mutual fund investment into cash. Investing in a mutual fund makes you a shareholder and owner in proportion to the gains and losses in the fund. As a shareholder you also have voting rights in proportion to your ownership. A prospectus provides a description of the mutual fund, its historical performance, investment policies and objectives, risks and costs.
  
  

Fund Classification

• Mutual funds are classified into several different categories. Bond funds pool investor money for investment in bonds. Bonds are IOUs of companies and governments that entitle investors to receive back their principal at maturity and period payment of interest. Stock fund invest in equities of corporations, representing part ownership as a shareholder. Stocks can be categorized based on market capitalization (shares outstanding multiplied by share price), or market-cap. For example, a mutual fund can invest solely in large-cap, mid-cap or small-cap stocks. Funds can also be classified by the type of stock such as "growth" (fast-growing companies) or "value" (stocks trading below their intrinsic value). Balance funds invest in a mix of stocks and bonds. Global funds invest in companies based abroad and sector funds invest in a particular sector such as technology of banks. Finally, index funds own a portion of the stock market, such as the S&P 500 Index.
  
  

Fees

• A shareholder incurs certain fees when he invests in a mutual fund aside from his minimum contribution, which can range between $1,000 and $10,000. A 12b-1 fees are promotion expenses such as advertising and public relations costs that must be borne by shareholders. Administration costs relate to the cost of record keeping, mailings and operational costs such as maintaining a customer help line. Administrative costs vary by mutual fund but well run funds tend to keep these costs low. For example, a frugal fund may keep admin costs below 0.20 percent of the fund's assets compared to another fund with twice as much administrative costs.
  
  

Mutual Fund Performance

• An investor can become dizzy with so many funds advertising their historical performance. Skeptics point to the fact that most mutual fund managers do no better than individual investors. However, others point to the benefit of diversification provided by mutual funds. A number of variables determine a fund's performance such as investment style and type of investment. Morningstar, a leading source for mutual fund research, created a rating system for rating mutual funds. Morningstar uses a scale of one to five stars that measures a fund's performance on return and risk basis. For example, the Fairholme (FAIRX) fund earned a Morningstar rating of five stars after posting an annual gain of 25 percent in 2010 compared to 15 percent for the S&P 500.