Mutual Fund Basics Tutorial

In a world where investing in the financial markets is a critical piece of our retirement planning, college savings, and healthcare balances, mutual funds – pooled investments under professional management – are becoming ubiquitous for the individual investor. Rather than picking stocks and managing money, mutual funds aggregate funds from many thousands of small investors and maintain a stated, disciplined investment strategy. Today, more than $4 trillion are invested in mutual funds in America, with the total number of funds growing from 68 in 1940 to more than 8,000 today.

Worldwide, nearly $28 trillion is invested in mutual funds. As the number of mutual funds has grown, so too has their scope and strategies. For example, as of 2013 in the U.S., there were 1,329 U.S. equity funds, 1,345 global funds and 1,866 total return funds, 594 investment grade bond funds, 225 high-yield bond funds, 270 global bond funds, 214 government bond funds, 143 multi-sector funds, 560 state and national municipal bond funds, 382 taxable money market funds and 173 tax-free money market funds. With the rise of 401(k) accounts and 529 college savings accounts (for example), it is estimated that today more than half of American households invest in mutual funds.

The mutual fund as we know it had its seeds planted in 1774 in the Netherlands as Europe emerged from an economic crisis following the collapse of the British East India Company. Many individual investors lost their entire life savings after that bubble burst, and so the idea of pooling investment risk was quite attractive. Adriaan van Ketwich, a Dutch merchant, had the insight to pool money in this way from a number of subscribers to form an investment trust – the world’s first mutual fund. The financial risk to the large number of mainly small investors was spread by diversifying investments across a number of European countries as well as the American colonies, where investments were backed by income from plantations. This first mutual fund was called “Eendragt Maakt Magt” (“unity creates strength”), and survived for fifty years until 1824.

The first modern mutual fund, the Massachusetts Investors Trust, was established in 1924. After just one year, the fund grew to from $50,000 to $392,000 in assets ($4.6 million in 2017 dollars). The fund went public in 1928 and eventually became known as MFS Investment Management.

Mutual funds are seen as a way for the little guy to get a piece of the market. Instead of spending all your free time buried in the financial pages of the Wall Street Journal, all you have to do is buy a mutual fund, and you'd be set on your way to financial freedom. As you might have guessed, it's not really that simple. Mutual funds are an excellent idea in theory, but, in reality, they haven't always delivered. Not all mutual funds are created equal, and investing in mutuals isn't as easy as throwing your money at the first salesperson who solicits your business. (Learn more: How To Pick a Good Mutual Fund.)

In this tutorial, we'll explain the basics of mutual funds and hopefully clear up some of the myths around them. You can then decide whether or not they are right for you.