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Learn The Basics of Investment Funds

March 05, 2021 · 6 minute read

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Learn The Basics of Investment Funds

A common and effective strategy for beginner investors is to start investing with an investment fund. Investment funds let investors pool resources to buy into a collection of securities.

What is an Investment Fund?

It’s common to wonder, what is a fund? Broadly speaking, an investment fund is a collection of funds from different people that is used to buy securities. Investors get the advantages of investing as a group (purchasing power) and own a portion of their investments equal to the money they have contributed.

There are different types of investment funds, including mutual funds, exchange-traded funds (ETFs), and hedge funds. Typically, these funds are managed by a professional investment manager who allocates investors’ money based on the type of fund and the fund’s goal. For this service, investors are generally charged a small fee that is a percentage of their investment amount.

What is a Mutual Investment Fund?

Mutual funds are popular investment funds for a reason: they are an easy way to purchase diversified assets—from stocks and bonds to short-term debt—in one transaction.

One of the core fundamentals that led to the creation of mutual funds is providing smaller individual investors access to investments that might be more difficult to obtain or manage on their own. A retail investor with $1,000 probably wouldn’t be able to effectively recreate a portfolio that tracks the S&P 500, let alone rebalance it quarterly. Thanks to the creation of mutual funds, investors can pool all of their funds together into a collective fund to invest in the same markets by choosing from custom-packaged funds with specific focuses and inexpensive share prices.

Different Types of Mutual Funds

There are a number of different types of mutual funds, each of which offer something distinct to the investor.

Equity Funds

Also known as stock funds, equity funds are a type of mutual fund that invests in a specific asset class, principally in stocks. Equity fund managers seek to outperform the S&P 500 benchmark by actively investing in growth stocks and undervalued companies that may provide higher returns over a period of time than the fund’s benchmark.

Equity funds have higher potential returns but are also subject to higher volatility as well. It’s common for equity funds to be actively managed and thus typically charge higher operating fees. Funds with higher stock allocations are more popular with younger investors as they allow for growth potential over time.

While equity is a specific asset investment by itself, some mutual funds focus on more precise criteria:

Fund Size (Market Cap)

Some funds only include companies with a defined market cap (market value). Different tiers of company sizes can perform differently in different economic conditions and companies can be viewed as more or less risky based on their market cap. Fund sizes are categorized by the following:

•  Large-Cap (Over $10 billion)
•  Mid-Cap ($2 billion to $10 billion)
•  Small-Cap ($300 million to $2 billion)

Industry/Sector

Funds that focus specifically on a single industry such as technology, healthcare, energy, travel, and more. Owning shares in different sector mutual funds provides portfolio diversity and can potentially enhance returns if a particular industry experiences a tailwind.

Growth vs. Value

Some funds differ in their investment style, focusing on either value or growth. Growth stocks are expected to provide outsized returns, whereas value stocks are considered to be undervalued.

International/Emerging Markets

Domestic stocks are not the only equity investment options, as some funds focus exclusively on international and emerging markets. International and emerging market funds provide geographic diversity—exposure to companies operating in different countries and countries with growing markets .

Bond Funds

Like stock mutual funds, bond funds are a pool of investor funds that are invested in short- or -long-term bonds from issuers such as the US government, government agencies, corporations, and other specialized securities. Bond funds are a common type of fixed-income mutual funds where investors are paid a fixed amount on their initial investment.

Seeing as how bonds are frequently thought of as a safer investment than stocks and offer less growth, bond funds are popular among investors who are looking to preserve their wealth as opposed to aggressively growing it.

Index Funds

This type of fund is constructed to track or match the makeup and performance of a financial market index such as the Standard & Poor’s 500 Index (S&P 500). They provide broad market exposure, low operating expenses, and relatively low portfolio turnover. Unlike equity funds, an index fund’s holdings only change when the underlying index does.

Index fund investing has exploded in popularity in recent years due to it’s low costs, passive approach, and abundance of options to pick from. Investors may choose from a number of indices that focus on different sectors such as the S&P 500 (financial and consumer), Nasdaq 100 (technology), Russell 2000 (small-cap), and international indices .

Balanced Funds

Also known as asset allocation funds, these hybrid funds are a combination of investments in equity and fixed-income with a fixed ratio such as 80% stocks/20% bonds. Balanced funds offer diversity to different asset classes and consequently trade some growth potential to mitigate some risk. One example of a balanced fund is a target-date retirement fund which automatically rebalances the investments from higher-risk stocks to lower-risk bonds as the fund approaches the target retirement date.

Money Market Fund

This low-risk, fixed-income mutual fund invests in short-term, high-quality debt from federal, state, or local governments, or US corporations. Assets commonly held by money market funds include U.S. Treasuries and Certificates of Deposit. These funds are among the lowest-risk investments and make up 15% of the mutual fund market.

Alternative Funds

For those seeking true portfolio diversity beyond traditional stocks and bonds, it may be worth considering alternative investment funds. Alternative funds focus on other specific markets such as real estate, commodities, private equity, or others.

These asset classes generally make up a small percentage of one’s portfolio, if at all, and serve as a hedge to heavier-weighted allocations to traditional sectors. Rather than investing in companies of a particular index or market cap, alternative funds may be composed of natural gas drilling companies, real estate investment trusts (REITs), intellectual property rights, or more.

Benefits of a Mutual Investment Fund

While no two funds are the same, mutual funds are a popular choice for beginner and advanced investors alike for a variety of reasons.

Diversification

Mutual funds serve as an investment basket that contains many different assets, some with the same general focus and others with multiple focuses. Rather than being all-in on one particular investment, mutual funds offer diversity across multiple investments.

This allows investors to cast a wider net and benefit when one or multiple of their basket investments performs well. Conversely, when one investment in a mutual fund does poorly, the investor may rest assured knowing that a single loss is mitigated by also having other investments that hopefully offset other losses. Some types of funds offer greater diversification across different asset classes, such as stocks and bonds.

Performance

Mutual funds that aim to track indices or focus on growth stocks typically yield similar market performance compared to the benchmark index. S&P Global’s Year-End 2019 report (the most recent year-end report to date) showed that 89% of active managers failed to match the benchmark large-cap S&P 500’s performance, the same measure commonly obtained by a simple mutual fund buy-and-hold strategy.

Low Maintenance

Mutual funds are relatively easy to use and require little to no maintenance. They allow investing in multiple asset classes through one investment vehicle without having the investor sift through and make individual decisions. All of these decisions are provided by an active fund manager whose sole responsibility is to provide profitable returns for investors based on the fund’s general focus or target.

Mutual funds also provide a degree of functionality. One convenient feature is the ability to set a passive monthly investment amount and to automatically reinvest dividends. Many mutual funds pay investors dividends on an annual, quarterly, or even monthly basis. Dividends are calculated based on the underlying companies’ earnings and distributed to the fund which then passes them along to fund investors. Another renowned feature of mutual funds is the ability to reinvest dividends, thus compounding both mutual fund holdings and dividends in perpetuity.

High Liquidity

Mutual funds are transacted frequently. Investors are able to easily buy or redeem mutual fund shares daily at the market open. Shares in funds are relatively affordable as they typically have a low net asset value (NAV), allowing even novice investors to buy shares with a low starting amount. Compare this to ETFs which can be transacted repeatedly at any time during market hours, but the price can rise to seemingly out-of-reach levels for a beginner.

Active Management

Mutual funds are actively managed by a professional fund manager who’s responsible for operating the fund, whether it be to allocate investor money, rebalance the fund’s investments, or distribute dividends to investors.

While mutual funds tend to have relatively low fees, investors are subject to an annual fee, also known as an also known as an expense ratio, that is calculated as a percentage of each individual’s holdings in the fund and automatically paid to the fund manager for their services. Fund fees vary, so in some cases it may be helpful to compare funds based fees before investing.

Can I Lose money in a Mutual Fund?

With investing, there is no such thing as a sure thing. While it’s unlikely, it is possible to lose all your money in a mutual fund if the securities in the fund drop in value.

That said, some mutual funds aim to be conservative and designed to offer slow but incremental gains over time. As always, it’s prudent to research exactly what’s contained in a particular mutual fund before investing any capital. Ultimately, it’s every investor’s responsibility to determine their own risk tolerance and investing strategy that meets their personal needs.

The Takeaway

Investment funds are a practical and beginner-friendly way to start investing in financial markets. Even with beginner knowledge around what is a mutual investment fund, mutual funds have the propensity to provide a hands-off and a potentially low-cost way to start building wealth. Mutual funds offer options focusing on many asset classes, time horizons, and risk tolerances for investors of all ages and experience levels.

Short-term fluctuations may occur on a day-to-day basis, but investing in a long-term investment fund like a mutual fund is a popular strategy to build long-term wealth. For both experienced and first-time investors, the SoFi Invest® online trading app offers automated and active investing options that aim to work with most goals.

See which type of investment fund is right for you and start investing now with SoFi.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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