Mutual funds are a great investment option for younger Americans or novice investors. They have every element a young investor should look for including easy access; they are relatively easy to understand; good diversification even if you do not have a lot of money to spread around; and the potential for good growth. Even though mutual funds make sense for a lot of investors, it can be intimidating to get started investing in them. Financial professionals and fund companies often speak a different language when they rattle on about expense ratios or Lipper average] ratings. It may seem risky to throw your money into an asset you do not understand and do not feel you can control.

A lot of young workers already invest in mutual funds through their 401(k) or 403(b) plans. These are employer-sponsored retirement accounts, but the overwhelming majority of money in these plans goes toward mutual funds. If a mutual fund is good enough for your company 401(k), chances are it is good enough for your personal investments, especially if it is in an IRA.

What Is a Mutual Fund?

A mutual fund is both an investment and an actual company. This may seem strange, but it is actually no different than how a share of AAPL is a representation of Apple, Inc. When an investor buys Apple stock, he is buying part ownership of the company and its assets. Similarly, a mutual fund investor is buying part ownership of the mutual fund company and its assets. The difference is Apple is in the business of making smartphones and tablets, while a mutual fund company is in the business of making investments.

Mutual funds pool money from the investing public and use that money to buy other securities, usually stocks and bonds. The value of the mutual fund company depends on the performance of the securities it decides to buy. So when you buy a share of a mutual fund, you are actually buying the performance of its portfolio.

The average mutual fund holds hundreds of different securities, which means mutual fund shareholders gain important diversification at a very low price. To see why this is important, consider an investor who just buys Google stock before the company has a bad quarter. He stands to lose a great deal of value because all his dollars are tied to one company. On the other hand, a different investor may buy shares of a mutual fund that happens to own some Google stock. When Google has a bad quarter, she only loses a fraction as much because Google is just a small part of the fund's portfolio.

How Mutual Fund Companies Work

Mutual funds are virtual companies that buy pools of stocks and/or bonds as recommended by an investment advisor and fund manager. The fund manager is hired by a board of directors and is legally obligated to work in the best interest of mutual fund shareholders. Most fund managers are also owners of the fund, though some are not.

There are very few other employees in a mutual fund company. The investment advisor or fund manager may employ some analysts to help pick investments or perform market research. A fund accountant is kept on staff to calculate the fund's net asset value (NAV), or the daily value of the mutual fund that determines if share prices go up or down. Mutual funds need to keep a compliance officer or two, and probably an attorney, to keep up with government regulations.

Most mutual funds are part of a much larger investment company apparatus; the biggest investment companies have hundreds of separate mutual funds. Some of these companies should be familiar to the general public, such as Fidelity Investments, the Vanguard Group, T. Rowe Price and Oppenheimer Funds.

Kinds of Mutual Funds

Mutual funds are divided into several kinds of categories, each of which can contain hundreds or thousands of different funds. The purpose of fund categories is to help investors understand what kinds of securities the mutual fund manager is going to buy and how he intends to generate returns for the shareholders.

For example, one of the largest categories of mutual funds is the "fixed income" category. A fixed income mutual fund focuses on investments that pay a fixed rate of return, such as government bonds, corporate bonds or other debts. The idea is the fund portfolio generates a lot of interest, which can then be passed on to shareholders.

Another group of funds falls under the moniker "index funds." These are designed with cost-sensitive investors in mind, and the investment strategy is based on the belief that it is very hard, and often expensive, to try to consistently beat the market. So the index fund manager simply buys stocks that correspond with a major market index such as the S&P 500 or the Dow Jones Industrial Average. This strategy requires less research from analysts and advisors, so there are fewer expenses to eat up returns before they are passed on to shareholders.

Other common types of mutual funds are money market funds, balanced funds, sector funds, equity funds and even funds-of-funds, or mutual funds that buy shares of other mutual funds.

How to Begin Investing in Mutual Funds

The Internet has made it much easier to buy and sell mutual funds. Every mutual fund comes with a small packet of information called a fund prospectus. The prospectus contains information about costs, fees, past performance and investment objectives. It is very important to review a fund's prospectus and ask questions before investing.

If you have a go-to broker or financial advisor, you may want to consider using him to set up your mutual fund account. He can help you wade through paperwork and offer recommendations about which funds are best suited to your needs. If you do not have an advisor, you can visit a fund company's website to find the prospectus. Call the fund company directly if you have questions or want to set up an account; it will walk you through the process and explain how to get started.

Mutual Fund Fees, Costs and Risks

All mutual funds come with risks, particularly the risk of investment loss. The Federal Deposit Insurance Corporation (FDIC) does not back up mutual fund investments, and there is no guarantee of performance with any mutual fund. Additionally, the NAV for a fund is not the full cost of purchase; you often have to pay a sales fee to the third party who helps you set up the account.

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