There is no strict legal definition of the term “mutual fund”. Usually, the term “mutual fund” means an investment fund that is open to the public. A mutual fund is a way of investing money collectively with other investors.
The main advantage of investing capital through a mutual fund is the reduction of risk.
If your money is invested in a single equity, it may do well, but it also may collapse for different reasons. If your money is invested in a number of equities or enterprises, the risk of them collapsing at the same time is less than the risk of a single entity collapsing. Thus, the risk of you losing your money goes down when your investments are diversified.
You might not have enough money to invest in different equities by yourself. A mutual fund pools your money together with other investors’ money. This enables a mutual fund to diversify its investments in ways unattainable to a small investor, lowering the risks and maximizing profits.
Another benefit of a mutual fund is that by pooling money from a number of investors together it can then afford to hire professionals to manage the money. While anyone can hire an investment advisor, it often doesn’t make financial sense for a small investor: the advice might cost more than the profit it brings. This problem does not exist when a significant amount of money is pooled together.
A typical mutual fund usually has an investment manager who manages investment decisions, a fund administrator who manages the trading and a board of directors or trustees who ensure compliance with laws. Shareholders of the fund own the assets and associated income.
There are two main types of mutual funds: open-end funds and closed-end funds.
An open-end fund is divided into shares which vary in price based on the value of fund’s net assets. Shares of an open-end fund are a direct reflection of its assets.
Shares of a closed-end fund are traded on a stock exchange. Based on the demand, shares of a closed-end fund may trade at a price that does or does not reflect net asset value of the fund’s assets.