Investment Funds: How They Work and Common Types
Learn more about what investment funds are, how they work, and different types, such as mutual funds and index funds.
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What is a fund?
A fund is cash saved or collected for a specified purpose, often professionally managed with the goal of growing the value of the fund over time.
In investing, funds pool money from shareholders to invest in assets such as stocks and bonds. One common example is a mutual fund.
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How do investment funds work?
Investment funds take the contributions of fund investors and purchase a portfolio that may include stocks, bonds, short-term debt or a combination of assets.
Investors don’t actually own the underlying assets but rather buy shares of the fund (which is why fund investors are known as shareholders). As the total value of the stocks or bonds within a fund rises and falls, so does the value of the fund shares.
According to the U.S. Securities and Exchange Commission, investors often choose mutual funds because they offer:
Professional management. The average investor likely doesn’t have the expertise to put together and manage an investment portfolio. Instead, fund managers do that heavy lifting for shareholders.
Affordability. Most mutual funds require a low minimum investment.
Liquidity. Fund investors can typically sell their shares at any time.
Instant diversification. Any investment in a single company’s stock is inherently risky. Funds reduce that risk as they often invest in a wide variety of companies, frequently in different industries. This diversification decreases the risk of losing your principal investment.
» Dive deeper: Best-performing mutual funds
Types of investment funds
Some common examples include:
Mutual funds take cash from a large group of investors and invest in stocks, bonds and other securities. Shares of mutual funds are bought and sold at the end of each trading day.
Money market funds are fixed-income mutual funds that invest in low-risk, short-term debt and can be easily turned into cash. Money market funds typically offer yields of around 4%.
Index funds are a type of mutual fund whose investments track a particular market index, such as the S&P 500. Index funds are a passive way to invest in the stock market.
Exchange-traded funds (ETFs) are funds similar to mutual and index funds, except they can be traded like stocks throughout the day on a stock market exchange.
Real estate investment trusts, also known as REITs, are companies that invest in real estate, income-producing properties like apartment buildings, hotels or malls. They are often compared to mutual funds because they typically hold a selection of real estate investments.
Hedge funds pool funds from prequalified investors, typically high-net-worth individuals and organizations. Hedge funds typically employ riskier trading strategies and charge high performance-based fees.
» Ready to get started? Check out the best brokers for mutual funds.
