What are mutual funds?

Mutual funds build wealth by pooling shareholder money to invest in a range of securities, such as stocks and bonds

Investors become shareholders in a mutual fund by buying shares in that fund. A mutual fund's share price, known as the net asset value (NAV), is determined by the total portfolio value divided by the number of shares held by shareholders.

Mutual funds are chosen based on an investor's goals, risk appetite and security preferences. For any investor, it's important to understand that mutual funds are actively managed and come with their own management costs, expense ratio and early withdrawal fees. These can vary significantly between funds.

A very popular alternative to mutual funds, which must be purchased through the fund manager, are exchange-traded funds (ETFs). ETFs usually have lower trading costs to mutual funds and are easily available to trade on the stock market through online brokers like CMC Markets.

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Advantages of mutual funds

Diversification: mutual funds give access to portfolios of hundreds of shares, bonds and other securities with a single trade.
Large member bases: some of the largest mutual funds host millions of shareholders and trillions of assets under management. Economies of scale reduce transaction costs of making individual investments.

Disadvantages of mutual funds

Extra fees: load, expense ratio, and early withdrawal fees are some of the additional costs that come with the active management of mutual funds.
Varied returns: performance is not guaranteed and annual returns can vary drastically depending on the mutual fund. Performance over time should be reviewed, alongside the net asset value (NAV) and assets under management.
Cash drag: due to the way shares in mutual funds are traded, cash must make up a large portion of portfolios so that transactions can be completed each day. This reduces the amount of fund resources being exposed to wealth-building markets.

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Mutual funds vs exchange-traded funds (ETFs)

While both mutual funds and ETFs have similar features and give investors access to a wide range of securities, they also have unique differences.

Mutual Funds	Exchange-traded funds (ETFs)
Usually actively managed by professional fund managers.	Usually passively managed, as they track a particular subgroup of securities at low operating costs.
Traded as shares directly from a mutual fund at the end of the day, based on the mutual fund's net asset value (NAV) per share.	Bought and sold as shares on a stock exchange at any time throughout the day, based on the market price.
Operating costs include expense ratios, load fees, withdrawal penalties.	Costs are limited to brokerage commissions