The performance of the mutual fund depends on the underlying assets that it holds. If these assets increase in value on net, so does the value of the fund's shares. Conversely, if the assets decrease in value, so does the value of the shares.

The fund manager manages the portfolio, deciding how to invest the money across sectors, industries, companies, etc., based on the declared strategy of the fund. Pooling money into a large fund allows individual investors to take part in a professionally managed diversified portfolio of securities that they otherwise wouldn't be able to, given their normal investment amounts. This diversification and access are a key benefit for individual investors looking at mutual funds.

Investors typically earn a return from a mutual fund in three ways:

1. Income is earned from dividends on stocks and interest on bonds held in the fund's portfolio, and it pays out nearly all of the income it receives over the year to fund owners in the form of a distribution. Funds often give investors a choice either to receive a check for distributions or to reinvest the earnings to purchase additional shares of the mutual fund.
2. Portfolio Distributions: If the fund sells securities that have increased in price, the fund realizes a capital gain, which most funds also pass on to investors in a distribution.
3. Capital Gains: When the fund's shares increase in price, you can sell your mutual fund shares for a profit in the market.

When an investor researches the returns of a mutual fund, he or she will generally come across "total return," or the net change in value, either up or down, of an investment over a given period. It includes any interest, dividends, or capital gains the fund generated as well as the change in its market value over some time. Total returns are typically calculated over periods of one year, five years, and ten years, as well as from the date the fund was first launched (its inception date).

There are several types of mutual funds available for investment, though most mutual funds fall into one of four main categories which include stock funds, money market funds, bond funds, and target-date funds.

As the name suggests, this fund primarily invests in equities or stocks. Within this category, there are several subcategories. Some equity funds are classified based on the size of the companies they target: small-cap, mid-cap, or large-cap. Others are identified by their investment strategy, such as aggressive growth, income-oriented, or value. Additionally, equity funds can be categorized based on whether they focus on domestic (U.S.) stocks or international equities. To grasp the range of equity funds, you can refer to a style box, an example of which is provided below.

Small-cap companies are defined as those with a market capitalisation of under ₹5,000 crores. These firms tend to be smaller and possess considerable growth potential. However, they also carry a higher risk due to their lower likelihood of long-term success, which contributes to the volatility of their stocks. Historically, small-cap companies have struggled to perform well, but during periods of economic recovery, their stocks frequently emerge as top performers.

A mutual fund that guarantees a minimum return falls under the fixed income category. These funds primarily invest in assets that provide a consistent rate of return, including government bonds, corporate bonds, and various debt instruments. The interest income generated by the fund's portfolio is distributed to the shareholders.

Often called bond funds, these investment vehicles are typically actively managed and aim to purchase bonds that are considered undervalued, with the intention of selling them for a profit. While these mutual funds may offer higher returns, they also come with risks. For instance, a fund that focuses on high-yield junk bonds carries significantly more risk compared to one that invests in government securities.

Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest, and all bond funds are subject to interest rate risk.

Index funds invest in stocks that track major market indices like the S&P 500 or the Dow Jones Industrial Average (DJIA). This approach demands less research from analysts and advisors, which means lower costs for shareholders. As a result, these funds are typically tailored for cost-conscious investors.

Balanced funds invest in a mix of asset classes, including stocks, bonds, money market instruments, and alternative investments. The goal of this type of fund, often referred to as an asset allocation fund, is to minimize risk by diversifying across different asset classes.

Some funds are designed with a fixed allocation strategy, allowing investors to have a consistent exposure to different asset classes. In contrast, other funds adopt a dynamic allocation strategy that adjusts percentages to align with various investor goals. This approach can involve reacting to market trends, shifts in the business cycle, or the evolving stages of the investor's life.

The portfolio manager is commonly given the freedom to switch the ratio of asset classes as needed to maintain the integrity of the fund's stated strategy.

The money market is made up of secure, low-risk, short-term debt instruments, primarily government Treasury bills. While investors may not see significant returns, their principal is assured. Typically, the returns are slightly higher than what one would earn in a standard checking or savings account, but a bit lower than the average certificate of deposit (CD).

Income funds are designed to deliver consistent income over time. They mainly invest in government bonds and high-quality corporate debt, holding these bonds until they mature to generate interest payments. Although the value of the fund's holdings may increase, the main goal is to ensure a reliable cash flow for investors. Consequently, these funds typically attract conservative investors and retirees.

An international fund, also known as a foreign fund, focuses solely on assets situated outside the investor's home country. In contrast, global funds have the flexibility to invest in markets worldwide. The volatility of these funds is often influenced by the specific economic and political risks of the countries in which they invest. Nevertheless, incorporating these funds into a well-balanced portfolio can enhance diversification, as returns from foreign markets may not always align with those from the investor's home market.

Sector funds are specialized investment funds that focus on particular sectors of the economy, like financial services, technology, or healthcare. These funds can experience significant volatility because the stocks within a specific sector often move in tandem with one another.

Regional funds simplify the process of concentrating on a particular geographic area. This could involve targeting a larger region or honing in on a single country.

Socially responsible funds, also known as ethical funds, focus their investments on companies that align with specific guidelines or values. For instance, many socially responsible funds avoid investing in "sin" industries like tobacco, alcohol, weapons, or nuclear energy. Conversely, some funds concentrate on green technologies, including solar and wind energy or recycling initiatives.

A mutual fund incurs annual operating fees or shareholder fees. These fees are typically a small percentage of the total funds under management, usually less than 1%, and are referred to as the expense ratio. The expense ratio of a fund includes both the advisory or management fee and its administrative costs.

Shareholder fees include sales charges, commissions, and redemption fees that investors pay directly when they buy or sell funds. Sales charges or commissions are commonly referred to as "the load" of a mutual fund. If a mutual fund has a front-end load, fees are charged at the time of purchase. Conversely, with a back-end load, fees are applied when investors sell their shares.

Sometimes, an investment company may provide a no-load mutual fund, which means there are no commissions or sales charges involved. These funds are sold directly by the investment company instead of going through a third party. Additionally, some funds may impose fees or penalties for early withdrawals or for selling the investment before a certain period has passed.

Typically, individual investors buy mutual funds with A-shares via a broker. This purchase often comes with a front-end load that can reach 5% or more, in addition to management fees and ongoing distribution fees, referred to as 12b-1 fees. Financial advisors promoting these products might urge clients to opt for higher-load options to earn commissions. With front-end funds, investors incur these costs at the time of their investment in the fund.

To address these issues and comply with fiduciary-rule standards, investment companies have introduced new share classes, such as "level load" C shares. These shares typically do not have a front-end load but do include an annual 12b-1 distribution fee that can be as high as 1%.

Funds that charge management and other fees when an investor sells their holdings are classified as Class B shares.

Investing in mutual funds is a fairly straightforward process that involves the following steps:

1. Make sure you have a brokerage account with enough cash on hand, and with access to mutual fund shares.
2. Identify specific mutual funds that align with your investment goals regarding risk, returns, fees, and minimum investments. Numerous platforms provide tools for screening and researching funds.
3. Decide how much you want to invest at the start and place your trade. If you prefer, you can usually set up automatic recurring investments as you wish.
4. Monitor and review performances periodically, making adjustments as needed.
5. When it is time to close your position, enter a sell order on your platform.

The value of a mutual fund is determined by how well the securities within it perform. When an investor purchases a unit or share of a mutual fund, they are essentially buying a portion of its portfolio's performance or, more specifically, a fraction of its overall value. Investing in mutual fund shares is different from investing in individual stock shares. Unlike stocks, mutual fund shares do not provide holders with voting rights. A share in a mutual fund represents investments across a variety of stocks or other securities.

The price of a mutual fund share is known as the net asset value (NAV) per share, which is sometimes abbreviated as NAVPS. To calculate a fund's NAV, you divide the total value of the securities in the portfolio by the total number of shares that are outstanding. Outstanding shares include those held by all shareholders, institutional investors, and company officers or insiders.

Mutual fund shares are usually bought or sold at the fund's current net asset value (NAV), which remains stable during market hours and is finalized at the end of each trading day. The price of a mutual fund is also adjusted when the NAV per share (NAVPS) is determined.

A typical mutual fund consists of a variety of securities, providing shareholders with diversification. For instance, think about an investor who only purchases Google stock and depends solely on the company's performance. Since all their investment is concentrated in one company, their financial outcomes hinge entirely on its success. In contrast, a mutual fund might include Google among its holdings, allowing the performance of other companies in the fund to balance out the fluctuations of a single stock.

There are several reasons why mutual funds have become the preferred investment option for retail investors, with a significant portion of funds in employer-sponsored retirement plans allocated to mutual funds.

Investors have the flexibility to explore and choose from a range of managers who employ different styles and management objectives. A fund manager might concentrate on value investing, growth investing, developed markets, emerging markets, income generation, or macroeconomic strategies, among various other approaches. This diversity enables investors to access not just stocks and bonds, but also commodities, international assets, and real estate through specialized mutual funds. Mutual funds offer avenues for both foreign and domestic investments that might not be readily available to typical investors.

Mutual funds are subject to industry regulation that ensures accountability and fairness to investors.

Liquidity, diversification, and professional management all make mutual funds attractive options; however, mutual funds have drawbacks too.

As with many investments that don't come with a guaranteed return, there's always a chance that the value of your mutual fund could decrease. Equity mutual funds are subject to price changes, just like the stocks within the fund's portfolio. It's important to note that mutual fund investments are not insured by the Federal Deposit Insurance Corporation (FDIC).

Mutual funds need to keep a substantial portion of their portfolios in cash to handle daily share redemptions. To ensure they have enough liquidity for withdrawals, these funds usually hold more cash than an average investor would. Since cash doesn't generate any returns, it's commonly known as "cash drag."

Mutual funds offer investors the benefit of professional management, but they also come with fees that can diminish the overall returns for investors, regardless of how well the fund performs. Because these fees can differ significantly from one fund to another, overlooking them can lead to unfavorable long-term effects, especially since actively managed funds face transaction costs that build up over time.

"Diworsification"—a clever twist on words—refers to an investment or portfolio strategy suggesting that excessive complexity can yield poorer outcomes. Many mutual fund investors often make things more complicated than necessary. They tend to buy too many funds that are closely related, which ultimately diminishes the advantages of diversification.

Dilution can also occur when a successful fund becomes too large. When new investments flow into funds with strong performance histories, the manager may struggle to identify appropriate opportunities for all the additional capital to be effectively utilized.

The Securities and Exchange Commission (SEC) mandates that funds must invest at least 80% of their assets in the specific type of investment indicated by their names. How the remaining assets are allocated is at the discretion of the fund manager. However, the categories that qualify for this 80% can be somewhat ambiguous and broad. This allows a fund to potentially mislead prospective investors through its name. For instance, a fund that primarily invests in Argentinian stocks might be marketed under a more general title like "International High-Tech Fund."

A mutual fund lets you convert your shares into cash whenever you want. However, unlike stocks that can be traded throughout the day, most mutual fund redemptions occur only at the end of each trading day.

When a fund manager sells a security, it triggers a capital-gains tax. However, taxes can be reduced by investing in tax-sensitive funds or by keeping non-tax-sensitive mutual funds in a tax-deferred account, like a 401(k) or IRA.

Researching and comparing funds can be quite challenging. Unlike stocks, mutual funds don't provide investors with the ability to directly compare metrics like the price to earnings (P/E) ratio, sales growth, earnings per share (EPS), or other key data. While a mutual fund's net asset value can serve as a point of reference, the variety of portfolios makes it tough to make direct comparisons, even among funds that have similar names or objectives. Typically, only index funds that track the same markets are truly comparable.

One of the most prominent mutual funds is Fidelity Investments' Magellan Fund (FMAGX). Launched in 1963, the fund aimed for capital appreciation through investments in common stocks. Its peak success occurred from 1977 to 1990, during which Peter Lynch was the portfolio manager. Under Lynch's leadership, the assets managed by Magellan skyrocketed from $18 million to $14 billion.

Fidelity's performance remained robust, with assets under management (AUM) reaching almost $110 billion by 2000. By 1997, the fund had grown so large that Fidelity decided to close it to new investors, not reopening it until 2008.22

As of February 2023, Fidelity Magellan has around $30 billion in assets and has been under the management of Sammy Simnegar since February 2019. The fund primarily uses the S&P 500 as its benchmark.

Index funds are a kind of mutual fund designed to match the performance of a specific market benchmark, or index. For instance, an S&P 500 index fund follows that index by investing in the 500 companies in the same proportions as the index itself. One of the main objectives of index funds is to keep costs low in order to closely reflect their index.

In contrast, actively managed mutual funds aim to outperform the market by selecting specific stocks and adjusting their allocations. The fund manager makes decisions based on their investment strategy and research to achieve returns that exceed a benchmark.

Index funds offer market returns at lower costs, while active mutual funds aim for higher returns through skilled management that often comes at a higher price. Investors should consider costs, time horizons, and risk appetite when deciding between index or managed mutual fund investing.