What Is a Mutual Fund and Why Should I Invest in One?

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Wall Street recently observed the centennial for one of investing's most critical and ubiquitous vehicles: the mutual fund.

Technically, mutual funds have existed in some form since the late 19th century. But the modern, open-ended mutual fund we know and love came to life on March 21, 1924, with the birth of the Massachusetts Investors Trust (MITTX), still offered up today by MFS Investment Management.

Since then, mutual funds have grown into a $28.5 trillion-plus market in the U.S. alone, according to the Investment Company Institute (ICI) 2025 Investment Company Fact Book.

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Regardless, the mutual fund might be new to you, and that's all that matters.

We're here to help you understand mutual funds a little better.

What is a mutual fund and how does it work?

An investment fund is a pool of money from several investors that an investment firm uses to buy stocks, bonds and/or other assets.

A mutual fund is just one type of investment fund, alongside exchange-traded funds (ETFs), closed-end funds (CEFs) and others.

And mutual funds are largely defined by how they operate.

When an investor gives money to a mutual fund provider, fund management takes that money and invests it in assets. In exchange, investors receive shares of the mutual fund.

While an investor doesn't actually own any of the securities in the fund, they still are a partial owner of the fund. Thus, they're entitled to a proportional share of the profits – be they dividends, interest income, capital gains, etc. – after backing out fund expenses.

The fund's price is based on its net asset value (NAV), which is the total value of the securities in the fund's portfolio, less fees and expenses, divided by the fund's outstanding shares. That price is calculated just once per day – unlike stocks, where trades are processed as they occur throughout the trading day, mutual fund trades all settle after the close of business.

That share price usually isn't important for purposes of buying the fund, however. You typically can pay a flat dollar amount – $50, $100, $1,000, and so on – which is a pretty flexible arrangement. On the flip side, many mutual funds require a minimum initial investment when first buying the fund, and those minimums can often stretch into the thousands of dollars.

I've mentioned "expenses" a couple times now. Running a fund costs money. A fund provider can have various costs, such as fund managers, administration, marketing, and the like. To recoup these costs, mutual funds charge various types of fees.

Most of these fees are expressed as the "expense ratio" – a percentage of the investment that will be automatically deducted from the fund's performance. A fund with a 1% expense ratio, for instance, charges $100 annually for every $10,000 invested.

But mutual funds can charge other fees, too. For instance, with a front-end sales charge, or "load," a portion of the initial investment is immediately taken out. So, if you invest $10,000 with a 5% front-end load, $500 would instantly go toward fees (and thus wouldn't be invested).

What are the types of mutual funds?

This question has a few different answers, as there's more than one way to categorize mutual funds.

My colleague, Jeff Reeves, has a longer explanation about what are the types of mutual funds, including breaking them down by asset class. But another important way to differentiate funds is by how they're managed.

Actively managed funds are run by one or more investment managers, who research, buy, monitor and sell investments within the fund. While they typically operate under some general guidelines – a blue-chip fund manager likely won't invest in micro-cap stocks – they often have broad leeway to invest as they see fit.

Index funds, however, invest automatically based on a rules-based index, like the S&P 500. So, for instance, an index mutual fund might track an index of large-cap tech stocks. As stocks enter the index, the fund is required to buy them in a manner that matches their weight in the index – and as they leave, the fund is required to sell them under the same parameters.

Because index funds don't require human managers (who in turn require salaries), they're often able to charge much lower fund fees. And broadly speaking, index funds on average tend to outperform professional managers.

On the flip side, index funds are constrained – they must buy what the index says they must buy, even if it might make poor investment sense. They also can't, say, exploit a quick period of extremely cheap valuations in a stock – a human manager can be much more agile because they're not being held back.

Also, manager expertise can provide more alpha in certain areas of the market, such as small-cap stocks and emerging markets.

What are the pros and cons of mutual funds?

Let's look at a few upsides and downsides of using mutual funds:

Pros

Diversification: A mutual fund allows you to invest in tens, hundreds, even thousands of stocks, bonds and/or other assets with a single purchase. That helps disperse your risk across a great number of investments.

Ease of Use: You can buy or sell a mutual fund with a few clicks of a mouse, which is infinitely easier than having to buy and manage all those individual holdings yourself.

High liquidity: Mutual funds are considered pretty liquid – you can sell your shares and receive your money within days.

Automatic reinvestment plans: Virtually any investment account will allow you to automatically reinvest dividends and other returns from mutual funds. Reinvesting like this can boost the pace at which your money grows.

They only trade once per day: The fact that mutual funds trade once per day is both a blessing and a curse. The blessing? Stocks, ETFs and other assets that trade throughout the trading day can be susceptible to flash crashes, which can prompt panicked investors to sell – even if doing so wouldn't be in their best long-term interest. Mutual funds, which only change prices once a day, can be more conducive to a steadier hand.

Cons

Investment minimums: While there are exceptions, most mutual funds still require some minimum initial investment outside of a 401(k) – and oftentimes, that number is in the thousands of dollars. That's a burden for most people, but it's especially cost-prohibitive for many beginner investors.

More types of fees: This is one of the core differences between mutual funds and ETFs. Both ETFs and mutual funds charge investment management fees. But with ETFs, that's it – no more fees. Mutual funds, however, can charge 12b-1 marketing fees, sales loads, and other fees, which can make them far more expensive than comparable ETFs. (Also, the vast majority of mutual funds are actively managed, whereas the vast majority of ETFs are index funds, which creates even more discrepancy in average fees.)

Tax inefficiency: Because of the way mutual funds are constructed, the buying and selling of stocks and other assets within a mutual fund create taxable events. While they can cancel each other out, mutual funds may have to make capital gains payouts – forcing investors to account for them in their taxes, even if they haven't sold any shares themselves.

They only trade once per day: The curse of trading once per day is that you can't use mutual funds tactically. Intraday trading with mutual funds is impossible, making them ill-suited for swing and day traders.

Kyle Woodley is the Editor-in-Chief of WealthUp, a site dedicated to improving the personal finances and financial literacy of people of all ages. He also writes the weekly The Weekend Tea newsletter, which covers both news and analysis about spending, saving, investing, the economy and more.

Kyle was previously the Senior Investing Editor for Kiplinger.com, and the Managing Editor for InvestorPlace.com before that. His work has appeared in several outlets, including Yahoo! Finance, MSN Money, Barchart, The Globe & Mail and the Nasdaq. He also has appeared as a guest on Fox Business Network and Money Radio, among other shows and podcasts, and he has been quoted in several outlets, including MarketWatch, Vice and Univision. He is a proud graduate of The Ohio State University, where he earned a BA in journalism.

You can check out his thoughts on the markets (and more) at @KyleWoodley.