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Mutual Funds

mutual fund is an investment shell.

Within the shell are a large number of investments, usually stocks and/or bonds. When all of the investments are bundled together into a fund, people can purchase shares in the mutual fund. Having mutual fund shares means an investor owns part of the investment shell – regardless of which underlying investments are bought or sold.

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Mutual funds are managed by an individual or a team of people with very high levels of investment expertise – often called fund managers. Fund managers have a tremendous influence upon the success or failure of a mutual fund, which is why a fund manager’s track record is an important element in deciding whether to invest in that fund.

There are stated investment objectives that guide fund managers as they decide which categories of investments to buy. While the stated objectives are intended to define how a fund is investing, other third parties – like Morningstar – assign a style to each fund based on their own analysis.

Styles help investors make meaningful comparisons between funds by assigning them to categories based on common category traits. Mutual funds can drift between styles over time. Styles usually reflect some or most of the following characteristics:

  • Type of investment – like stocks or bonds
  • The country or geographic region of the investment – like Domestic (US) and Foreign (Outside the US)
  • The economic conditions of the country – like Developing Countries
  • The size of companies in which the fund invests – like Large Cap, Medium Cap and Small Cap
  • The relative value of company’s stock – like Value, which means the stock is undervalued and expected to gain value
  • A sector of business – like Energy, Precious Metals or Real Estate

There are two mutual fund styles that are often confused: money market funds and stable value funds.

Money Market Funds

A money market fund is an investment fund that has the stated objective of earning interest for shareholders while maintaining a net asset value of $1 per share. Money market fund portfolios are comprised of short-term investments – generally 12 months or less – that represent high-quality liquid debt and monetary instruments. A money market fund is typically the lowest-risk and lowest-potential-return fund option in a retirement plan.

Stable Value Funds

A stable value fund is an investment fund that holds high-quality bonds and interest-bearing contracts purchased from banks and insurance companies. The interest-bearing contracts have a guarantee, called a wrapper, that the principal and interest payments will remain steady. The wrapper also guarantees that the net asset value will remain stable for a specified period of time, regardless of market conditions. Stable value funds are often offered as an alternative to money market funds in retirement plans. Depending upon market conditions, stable value can return more or less than a money market fund.