What's the difference between a mutual fund and a hedge fund?

By Investopedia Staff AAA
A:

These two types of investment products have their similarities and differences.

First, the similarities:
Both mutual funds and hedge funds are managed portfolios. This means that a manager (or a group of managers) picks securities that he or she feels will perform well and groups them into a single portfolio. Portions of the fund are then sold to investors who can participate in the gains/losses of the holdings. The main advantage to investors is that they get instant diversification and professional management of their money.

Now, the differences:
Hedge funds are managed much more aggressively than their mutual fund counterparts. They are able to take speculative positions in derivative securities such as options and have the ability to short sell stocks. This will typically increase the leverage - and thus the risk - of the fund. This also means that it's possible for hedge funds to make money when the market is falling. Mutual funds, on the other hand, are not permitted to take these highly leveraged positions and are typically safer as a result.

Another key difference between these two types of funds is their availability. Hedge funds are only available to a specific group of sophisticated investors with high net worth. The U.S. government deems them as "accredited investors", and the criteria for becoming one are lengthy and restrictive. This isn't the case for mutual funds, which are very easy to purchase with minimal amounts of money.

For further reading on these two types of funds, please see our Mutual Fund Basics tutorial and our article Taking a Look behind Hedge Funds.

RELATED FAQS

  1. What are the advantages of an index fund over an ETF?

    Diversifying a portfolio is one of pillars of investing basics, and an index fund can provide an investor with exposure to ...
  2. Are warrants more desirable than options?

    Understand what stock warrants are, the differences between warrants and options, and learn whether warrants or options are ...
  3. What techniques are most useful for hedging exposure to the metals and mining sector?

    Learn what methods traders use to hedge their exposure to the metals and mining sector. These methods include purchasing ...
  4. How does the risk of investing in the financial services sector compare to the broader ...

    Learn how the financial services sector compares in risk to the broader market and what key attributes make financial services ...
RELATED TERMS
  1. Next Generation Fixed Income (NGFI)

    Next generation fixed income is an innovative approach to investing ...
  2. Real Estate

    Land plus anything on it, including buildings and natural resources.
  3. Smart Beta

    Investment strategies that emphasize the use of alternative weighting ...
  4. Discretionary Investment Management

    A form of investment management in which buy and sell decisions ...
  5. Account Minimum

    The minimum balance required to be maintained in an investment ...
  6. Capital Growth

    The increase in value of an asset or investment over time. It ...

You May Also Like

Related Articles
  1. Stock Analysis

    Is Prospect Capital Exposed To Elevated ...

  2. Trading Strategies

    Top Day Trading Instruments

  3. Mutual Funds & ETFs

    These 4 Precious Metals ETFs Help Combat ...

  4. Mutual Funds & ETFs

    PIMCO vs. BlackRock: Weighing Mega Fund ...

  5. Mutual Funds & ETFs

    Buying ETFs on Margin Versus Leveraged ...

Trading Center