What exactly is a mutual fund?
Why invest in mutual funds?
What are the advantages and disadvantages of mutual funds compared to investing in individual stocks?
What is the net asset value?
What is the difference between a closed-end mutual fund and an open-end mutual fund?
What is a "no-load" mutual fund?
What is a 12b-1 fee?
What is a prospectus?
How are mutual fund managers compensated?
What is the difference between a growth and a value mutual fund?
What is the capitalization? Should I invest in a small-cap fund or a large-cap fund?
What is a balanced fund?
What is an asset allocation fund?
What is an Equity-Income Fund?
What is a sector fund?
Is there a difference between a global mutual fund and an international mutual fund?
What's the difference between a long-term gain, a short-term gain and a dividend?
What is dollar cost averaging, and what does it do?
How do I go about selecting a mutual fund?

What exactly is a mutual fund?
A mutual fund is a type of investment that allows individual investors to pool their cash together and invest in securities. This pool of money can be used to invest in stocks, bonds, options, real estate, or a variety of other investments, subject to the terms of the prospectus for the mutual fund. The most popular types of mutual funds are stock (or equity) mutual funds, and bond mutual funds. 

Why invest in mutual funds?
The mutual fund investor has the benefit or professional management of assets. These professionals have research, data and experience not possessed by the average investor. Investing in mutual funds also offers the individual investor the opportunity to create a well-diversified portfolio of holdings with less money than would be necessary with a portfolio of individual securities.

What are the advantages and disadvantages of mutual funds compared to investing in individual stocks?
The biggest advantage is diversification, or spreading of risk. A mutual fund is typically invested in scores, and sometimes hundreds of stocks or bonds, and this can reduce risk to the investor, who may otherwise be forced to invest in a small number of stocks or bonds due to dollar limitations. Two other advantages are professional management provided by the fund company, and ease of buying and selling shares of the fund.

The disadvantages may include over diversification of a portfolio, rather than concentration in one or more stocks. This can dilute potential returns. In addition, mutual fund investors are unable to control the tax consequences involved in transactions made by the mutual fund.

What is the net asset value?
The net asset value, or NAV, of a mutual fund is the underlying value of one share of the mutual fund. As the investments made by a mutual fund go up or down in value, the net asset value of the mutual fund shares fluctuate accordingly.

What is the difference between a closed-end mutual fund and an open-end mutual fund?
Closed-end funds and open-end funds are distinguished by the manner in which investments and liquidations are made. Open-end mutual fund companies sell shares at the net asset value to investors, and agree to buy shares back from investors upon demand at the net asset value. Therefore, the number of shares outstanding is subject to change. A closed-end mutual fund offers a set number of shares to the public in an initial public offering, just like a stock. When the initial shares are sold, the closed-end mutual fund neither issues new shares nor redeems existing shares. The mutual fund shares then trade on an exchange, just like a stock. If a shareholder wants to liquidate a closed-end mutual fund, he must make the arrangements through a broker who will find a buyer. The seller may receive more or less than the underlying value (net asset value) of the shares. Conversely, an investor who wants to buy shares of a mutual fund must buy the shares through a broker from someone who holds the shares and is willing to sell them.

What is a "no-load" mutual fund, and who gets the "load"?
The term "load" refers to the sales charges that are loaded on to the purchase price of some funds to compensate the broker for his or her services. "No-load" funds are those funds that are sold directly to investors, with no sales charges levied. With load funds, as much as 9%, is paid to the broker and brokerage firm, which is deducted from the investment amount. There are some funds that charge a "low- load" generally around 3%. Some funds also have multiple share classes with different load structures. Generally, the "Class A" shares carry an up-front sales charge. "Class B" shares generally have no up-front sales charge, but have a declining sales charge each year, generally starting at 5% and reducing to zero at the end of five years. "Class C" share carry an additional ongoing charge of 1% each year. In order to understand all the charges levied by funds, it is important to read the fund prospectus carefully, particularly the section labeled "fees and expenses."

What is a 12b-1 fee?
A 12b-1 fee is an ongoing fee charged by a mutual fund that compensates the mutual fund company for the costs of attracting new shareholders. 12b-1 fees are usually less than .25% per year, and many mutual funds charge no 12b-1 fees at all. This number is disclosed in the prospectus.

What is a prospectus?
A mutual fund prospectus is a formal document issued to prospective investors in a mutual fund that details many aspects of the fund. The prospectus provides the most detailed information available on a mutual fund, and should be read carefully before any investment is made. Topics covered by the prospectus include security types the mutual fund can invest in, investment strategy, historical performance, costs, background on the fund management and fund custodians, process for buying and redeeming shares, services offered and fees. Delivery of a prospectus is mandated under Securities and Exchange Commission rules prior to the sale of a mutual fund.

How are mutual fund managers compensated?
Mutual fund managers are compensated by taking a small portion of mutual fund assets to pay for the costs of managing the fund. This management cost is represented by the mutual fund's expense ratio, which also covers the administrative costs. All mutual funds report expense ratios in the prospectus sent to new investors.

What is the difference between a growth and a value mutual fund?
Growth-oriented mutual funds seek to invest in companies with rapidly growing sales and earnings. These companies tend to have higher share prices relative to their earnings. The expectation is that their earnings will grow quickly and bring them to a price level comparable to other companies. These shares carry extra risk when they fail to meet these expectations of growth, and share prices have been known to plunge rapidly. However, these companies have a tendency to appreciate rapidly when they repeatedly show strong growth (like Microsoft). The smaller earnings of these companies mean they are making less money, and their rapid growth means they need to hold onto profits for reinvestment. The result is that these companies tend not to pay dividends. Growth managers have several different styles, including "earnings momentum," "emerging growth," and "growth-at-a-price" which describe the types of stocks these managers look for. Value-oriented mutual funds tend to invest in companies that are selling at lower prices relative to their earnings or accounting value. Some value investors focus on companies that may not have good prospects for increasing earnings, but already have good earnings per share and are paying a big dividend. This often includes companies like electric utilities and banks. Other value investors focus on companies that they think are just selling cheaply; maybe a company which has had problems for a few months but looks poised to make a turnaround, or companies in an industry which has better growth prospects than most analysts realize. A blend fund basically fits somewhere in the middle. It probably invests in average companies with average expected growth and dividends, or it invests in a mix of value and growth positions. Be careful when looking at a mutual fund not to judge its style by its name. Some value oriented mutual funds often mention "growth" in their names, because, after all, their objective is to grow wealth for their investors. One example is American Century Equity Growth, a large-cap value fund. Many growth- oriented funds will also include the word "value" so investors understand the fund is searching for companies that are correctly valued, even if they expect higher growth. Look carefully at how a fund actually invests before buying.

What is the capitalization? What does small capitalization fund or a large capitalization mean?
The capitalization of a company is the value of all of a company's outstanding shares of stock. It serves as a measure of how big a company is. Capitalization can be calculated by multiplying the number of outstanding shares for a company by the stock's price. Large-cap stock funds, which invest in the biggest, most stable (blue-chip) companies, tend to be the safest stock mutual funds, while small cap funds invest in smaller, more volatile companies. Smaller companies may offer greater long term potential for growth, if you can tolerate long periods of volatility, or rising and falling share prices.

What is a balanced fund?
A balanced, or hybrid, fund is a mutual fund that invests some portion of its assets in stock, and the remainder in bonds, in order to achieve both growth (from stocks) and income (from bonds). Although different funds keep different amounts in stocks and bonds, most tend to keep around 60% in stocks and 40% in bonds. Some managers have the discretion to change that ratio as they see fit. The mutual fund prospectus details the fund manager's flexibility to invest.

What is an asset allocation fund?
An asset allocation fund is similar to a balanced fund in that it splits its investment between stocks, bonds and cash. Asset allocation funds actively move money between these asset classes. By attempting to "time" the "markets", the manager hopes to obtain the best returns from both markets, while minimizing exposure to losses in weak markets. Of course, you run the risk that the manager will be in stocks before a big drop, or miss out on the gains of an unexpected stock market increase by holding too much in bonds or cash. Some asset allocation funds also try to determine which industries have the greatest potential for growth, and invest in stocks in those industries. Many asset allocation funds have wide jurisdiction to invest in other investments, such as foreign stocks and natural resources.

What is an Equity-Income Fund?
An Equity-Income fund invests in dividend-paying stocks in order to provide shareholders with high current income. Typical investments are large, stable companies paying a current dividend of 4-7%. Usually these are mature companies in stable industries that don't have great growth in earnings. Banks and utilities are good examples. This tends to be the most stable of the equity mutual fund types, and can be a good way to provide a source of ongoing income, while still providing equity exposure to offset inflation.

What is a sector fund?
Sector funds invest in the stocks of one particular industry, like transportation, computers or health care. Sector funds are a great way to invest in a particular industry, without having to worry about picking particular stocks. Keep in mind that these funds are not diversified, and can experience wild swings in price. Frequently some sector fund will wind up being the best performing mutual fund for three months, then fall to the bottom in the following three months. Sector funds are best used as a small part of a diversified portfolio to increase exposure to an industry that has especially strong potential for growth.

Is there a difference between a global mutual fund and an international mutual fund?
An international mutual fund invests solely in the stocks, bonds and securities of foreign companies and governments. A global fund invests in some mix of domestic and international securities. It is important to keep a mix of both US stocks and the stocks of foreign countries in a portfolio for diversification. Most managers of global funds will vary the percentage of assets that they invest in the US and abroad, depending on where they see the greatest potential for profits If you are only able to make investments in one mutual fund, investing in a global fund can give you exposure to the gains in many markets, and spread the risk of investment in one market. If you can invest in a few mutual funds, using a few domestic mutual funds and a couple international funds can give you the same exposure to different markets, but with better ability to control how much you have in US securities and overseas investments.

What's the difference between a long-term gain, a short-term gain and a dividend?
Mutual funds make money in three ways. First, they can receive interest on cash or bonds. Second, they can buy a stock and receive dividends from it. Third, they can buy assets and sell them at a gain. Every year, the mutual fund is forced to pay out substantially all of its gains to shareholders from these sources. Interest and dividends are lumped together as the dividend portion of the payment. If the mutual fund had a gain on an asset it held for less than a year, is distributed as a short-term capital gain. Gains on assets held over a year are distributed as long-term capital gains. This payout structure is arranged this way for tax purposes, although it does create some quirks. Taxes are due on all payments made by the mutual fund, even though you may have opted to reinvest the payouts in more shares. So even though you don't receive cash, you still face the taxes. Long-term gains are taxed at the long-term capital gains rate, regardless of how long you have held the fund. When gains are paid out by a mutual fund, you get some cash or new shares, but the value of your existing shares are reduced by the exact same amount. If you own one share of a mutual fund which sells at $20 per share and it then pays out $2 in gains and dividends, the share price drops to $18 and you have $2 in cash. You wind up with the same twenty dollars you started with. The payout is only an accounting measure. This means you should never buy a mutual fund just because it is about to make a big payout. The payout won't make you any richer. In fact, if, as in the example above, you paid $20 for the mutual fund share, and receive the $2 payout, you have to pay taxes on the $2, even though you haven't made any money. You should try to avoid making large investments in a mutual fund right before a big distribution to avoid the tax consequences.

What is dollar cost averaging, and what does it do?
Dollar cost averaging is the process of buying mutual fund shares or stocks at regular intervals (usually monthly, quarterly or annually) in a fixed dollar amount. This means that your average share price is less than the average price over the period. Because you are buying a fixed dollar amount, you buy more shares when prices are cheaper, and fewer shares when they are more expensive. For example, let's say you buy $100 worth of mutual fund shares per month. The first month, the price is $10 per share, and you buy 10 shares. The second month, the price drops to $5 per share, and you buy 20 shares. The third month, the price goes to $15 dollar, and you buy 6.7 shares. By the fourth month, the price drops back to $10, where you first started buying. But, you didn't just break even. In total, you spent $300 dollars to buy 36.7 shares, which are now worth $367. This ability to smooth out the bumps in the market makes dollar cost averaging a great way to begin investing. Many mutual fund companies offer automatic investment plans in which you can specify exactly how much you want to invest each month. The mutual fund company then withdraws that amount from your checking account each month to invest in the mutual fund. Some companies even waive the initial minimum investment for participants in these plans. If you participate in a 401K or 403B plan at work, you are effectively dollar cost averaging.

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