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How Mutual Funds Work

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Pooling Funds of Multiple Investors Allows Larger Stock Purchases

Mutual funds are a popular, albeit often misunderstood, investment option. For the newer investor, mutual funds offer an alternative to risking precious money on a large number of different stocks or other investments.

Pooling of Funds is a Key Component

Mutual fund accounts contain a wide diversity of securities, permitting individuals to join others in making smaller investments, while creating dollar pools large enough to make significant purchases of quality stocks, precious metals, bonds, or U.S. Government obligations. This pooling of money gives the fund the financial strength to make both wise and large purchases. Pooling also permits smaller or less sophisticated investors to enjoy the benefits of owning a small percentage of a wide variety of quality investments, helping them reach a goal of diversity.

Higher Quality Securities for Smaller Investment

People with limited investment funds are often unable to purchase acknowledged quality stocks or precious metals. Mutual funds, although targeted to specific types of investments, can purchase larger blocks of more expensive stocks for the group of fund investors. Instead of being forced to buy penny stocks or lower priced securities, mutual fund participants own shares of a strong group of investments.

The size of their share will be based on the amount of their money invested in the mutual fund. The more monies invested, the larger share of the fund owned by the investor. Gains, losses, and income will accrue to each participant in direct relation to their level of investment.

Participants Need Not be Concerned About Purchases and Fund Management

The fund manager, highly trained and experienced in market trading techniques, maintains and controls the mix of investments in the fund so the participants need not be concerned with individual security trades. Investors should know the identities of the securities in their mutual fund, but need not worry about physically making trades.

Investors’ choices about which mutual funds to purchase will depend on a) the quality of the fund and its components, b) the quality of the fund manager, and c) the performance (earnings and growth) of the fund. They need not stress over the purchase or sale of individual securities, except as they relate to the overall composition of the mutual fund.

An Easier, Sometimes Safer Way to Invest and Diversify

Mutual funds, because of their diversity of securities, often outperform other investments in both the short- and long-term. However, as with all investments, there are no guarantees of high performance. In down economies, mutual funds typically suffer just as many individual stocks do. Yet, during the vagaries of normal stock market volatility, mutual funds can sometimes be safer options because of their diversity.