Investor Education

Investor Education
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Discovering Mutual Funds

Mutual fund basics

Millions of people choose mutual funds as a way to invest in the stock market. As you develop your investment goals and investigate different options, here’s some background information to help you understand mutual funds.

In this section:

Mutual funds are one of the best ways to invest in the stock market. Unlike investing in the stock of a single company, a mutual fund invests in a group of securities (such as stocks or bonds). A portfolio manager oversees the mutual fund and continually monitors its mix of holdings. The manager makes buy and sell decisions in order to meet the fund’s particular objective and strategies.

There are many styles, types and categories of mutual funds to choose from. This wide range of options makes mutual fund investing appropriate for most individual investing goals. Mutual funds are often used in IRAs, 401(k) plans, and other retirement savings vehicles, but they can also be used for non-retirement investing goals.

When you purchase shares in a mutual fund, you're actually buying shares of the companies that the mutual fund holds. Usually, a mutual fund's holdings—the stocks, bonds, or other securities a fund invests in—are similar in type (such as domestic or international) and category (like small cap or large cap). You can see a list of a mutual fund's holdings in its annual report.

The number of holdings in a mutual fund is the number of companies or other securities that are in the fund’s portfolio; this number will change as the fund manager decides what to buy and sell. The turnover rate of a fund measures the percentage of holdings that has been traded over the year. A high turnover rate means the fund manager shifts holdings around a lot; this can be riskier and may increase a fund's taxable distributions. A lower turnover rate is usually an indication that a portfolio manager has a "buy and hold" investment discipline, which means they have a stronger conviction in the long-term prospects of the companies they've chosen to hold in the fund.

When you invest in a mutual fund, you purchase your shares at the Net Asset Value (NAV), which is the price of one share at the close of a business day. It is also the price at which you would sell a share. One way you make money in a mutual fund is the simple difference between your buy and sell price.

Another way mutual funds make you money is by giving fund shareholders a distribution, usually on a quarterly or an annual basis, as required by the IRS. A distribution is a payment of a dividend or capital gain. Capital gain is when a fund sells its stock holdings for more than the purchase price. Dividends are payments a portfolio holding makes to the fund out of its current or retained earnings. When a mutual fund realizes profits from capitals gains, dividends, or interest, the IRS requires the fund to distribute these profits to its shareholders at least annually. The payment of this dividend or capital gain is called a “distribution” to the shareholder. If you are a shareholder in a fund, you will be taxed on the distributions you receive from the fund.

Most mutual funds are sold by a “parent” investment company that offers a selection of funds, often referred to as a “family of mutual funds.” A fund family often encompasses a range of fund styles, portfolio types and investment categories as well as strategic objectives.

While mutual fund companies vary widely in the size and scope of offerings, it is important to research the performance track record of a company as well as its investment philosophy. Every company treats mutual fund investing a little differently and it’s important to select a company that fits with your objectives and style of investing. You can learn about The Wasatch Way of investing here.

The approach to managing a mutual fund can vary widely, both in the philosophy of a mutual fund company and in the style of individual portfolio managers. However, there are two overall categories of mutual fund management.

Active fund management takes an independent, research-centric approach to determine what holdings a fund will include. Portfolio managers actively participate in researching and analyzing investments for a fund’s portfolio.

Passive fund management is more hands off. These funds seek to match the performance and risk of an overall market or a specific sector. Passive funds are also called index funds; their holdings mirror the composition of the market or sector.

At Wasatch, we believe that active management can help our investors take advantage of inefficiencies in the market that might not be readily apparent. For instance, great company management can’t be quantitatively measured. Likewise, a company may look good on paper, but a sense of chaos or mistrust might convince a portfolio manager that the company is not a wise investment. By relying on the intelligence, experience, and intuition of our portfolio managers, Wasatch Funds believes active fund management adds significant value over passive or index funds. Read more about our fund management style in the Wasatch Way here.