A mutual fund is a pooled investment vehicle managed by a professional investment firm. It collects money from individual investors and uses that capital to buy a diversified portfolio of stocks, bonds, or other securities. Each investor in the fund owns shares that represent a proportional stake in the overall holdings. These funds are structured to give access to professionally managed portfolios without requiring investors to select or trade individual assets themselves.
Mutual funds are structured as open-end investment companies, which means they issue and redeem shares on demand. Every trading day, investors can buy or sell mutual fund shares at the fund’s net asset value (NAV), calculated at market close. That makes them distinct from ETFs and closed-end funds, which trade throughout the day and can deviate from their underlying asset values.
Active versus passive management
Mutual funds come in two main types: actively managed and passively managed. Actively managed funds are run by portfolio managers who aim to outperform a benchmark index by selectively buying and selling securities. These funds are often marketed on the strength of the manager’s insight, process, or past success. In contrast, passively managed mutual funds aim to replicate the performance of a specific index, such as the S&P 500, by holding the same securities in similar proportions.
Over time, passive funds have gained popularity because of their lower fees and better long-term track record compared to most active funds. Despite that, a large number of mutual fund assets still sit in actively managed funds, especially in employer-sponsored retirement plans.
Fee structures and costs
Costs matter in mutual funds, and they come in more forms than many investors realize. The most obvious is the expense ratio, which covers the fund’s operating costs including management fees, administrative expenses, and marketing. Expense ratios for actively managed funds tend to be significantly higher than those of index funds.
Beyond the expense ratio, some mutual funds also charge front-end or back-end sales loads—commissions paid to brokers or financial advisors when buying or redeeming shares. Others include 12b-1 fees, which are annual marketing and distribution charges. Funds that do not charge these types of commissions are called no-load mutual funds and are generally considered more cost-efficient, especially for long-term investors.
Even seemingly small differences in cost compound over time. A 1% difference in annual fees may sound negligible, but over 30 years it can reduce final returns by tens of thousands of dollars. For this reason, many long-term investors actively seek no-load funds with low expense ratios.
Structure and liquidity
Mutual funds are priced once per day, based on the total value of the underlying assets divided by the number of shares outstanding. This price—known as the net asset value—is published after the market closes. Purchases and redemptions happen at this price, not during the trading day. That removes some of the intraday volatility associated with ETFs and individual stocks.
Liquidity in mutual funds is reliable for retail investors, though settlement typically takes a day or two. Investors place buy or sell orders through their brokerage or directly with the fund company, and the transactions settle based on the closing NAV. That makes mutual funds easy to use for recurring investments, systematic withdrawals, or rebalancing over longer periods.
Tax considerations
Tax efficiency is one area where mutual funds tend to lag behind ETFs. When mutual funds buy or sell securities inside the portfolio, they can generate capital gains. These gains, along with any dividends or interest earned, are passed on to investors, usually once per year. Even if you don’t sell your mutual fund shares, you may still owe taxes on those distributions in a taxable account.
This behavior makes mutual funds less predictable for tax planning. Index-based mutual funds usually generate fewer gains due to lower turnover, but they’re still more likely than ETFs to trigger taxable events. For that reason, many investors reserve mutual funds for tax-deferred accounts like IRAs or 401(k)s, where distributions don’t create immediate tax liability.
Mutual funds and diversification
One of the primary advantages of mutual funds is diversification. With a single purchase, investors gain exposure to dozens or even hundreds of securities. This reduces reliance on the performance of any single holding and lowers the risk that comes from concentrated bets. Diversification also makes it easier for smaller investors to own a broad mix of stocks or bonds without buying them individually.
Funds can be broad or narrow in scope. Some invest across entire markets, others focus on sectors, regions, or styles. For example, a large-cap growth fund might focus exclusively on U.S. tech companies, while a global balanced fund might mix equities and bonds from multiple countries.
Role in retirement and long-term portfolios
Mutual funds are a staple in retirement accounts and long-term investment plans. Their structure works well for automatic contributions, reinvested dividends, and dollar-cost averaging. Many 401(k) plans, for example, offer a selection of mutual funds covering different asset classes and risk levels. Target-date mutual funds are also common, automatically adjusting asset allocation based on the investor’s expected retirement year.
These funds are less appropriate for active traders or those seeking minute-by-minute control, but for long-term investors with a moderate level of engagement, mutual funds offer convenience, structure, and access to professionally managed portfolios without constant oversight.
How mutual funds differ from other fund types
Compared to ETFs, mutual funds don’t trade intraday, which makes them less flexible for short-term positioning. They also tend to have higher fees and less tax efficiency. On the other hand, mutual funds may offer advantages when it comes to automated investing and account integration, especially in retirement plans and custodial platforms.
Closed-end funds, meanwhile, are structured differently altogether. They raise a fixed amount of capital and then trade on secondary markets. Their prices can swing above or below the value of the underlying assets, which adds another layer of complexity not present in traditional mutual funds.
Finding the right fund
Choosing the right mutual fund depends on your goals, risk tolerance, and time horizon. Considerations should include the fund’s objective, cost, historical performance, manager tenure, asset mix, and how it fits into the rest of your portfolio. Avoiding unnecessary sales charges, keeping expense ratios low, and understanding how the fund behaves in different market environments can make a significant difference over time.
For investors looking to compare no-load mutual funds and keep investment costs under control, the main page includes additional information and resources.