Mutual Fund Basics
A mutual fund is a portfolio, or collection, of individual securities (some combination of stocks, bonds, or money market instruments) managed according to a specific objective spelled out in the fund's prospectus. With a mutual fund, you can pool your money with other investors, and then the fund invests it on your behalf.
Unlike individual stocks, whose value fluctuates minute by minute, mutual funds are priced at the end of each day the market is open, based on what the securities in the portfolio are worth. The price per share, or net asset value (NAV), of a mutual fund is the current market value of the fund's net assets divided by the number of shares outstanding. Investors buy and sell shares in the fund based on its NAV as of the next market close.
Benefits of a Mutual Fund
Diversification is one of the key reasons for investing in mutual funds. Most investors are concerned about the risks associated with financial markets—namely, that their investments will lose money or will not grow enough over time to outpace inflation and meet their future financial needs. While the risks of the stock market cannot be eliminated, there are various strategies used to reduce the level of risk. One such strategy is diversification.
With a single investment in a stock or bond, you can essentially have all of your eggs in one basket. By contrast, you gain exposure to dozens of securities in a mutual fund investment, thereby spreading your risk across securities. Assuming your mutual fund's portfolio is itself properly diversified, the Fund's value should not fluctuate as widely as the price of an individual stock.
Investing in several mutual funds with different investment objectives can result in even broader diversification. Mutual funds with only a few stocks in its portfolio or that focus solely on particular sectors (i.e., technology or healthcare) are considered non-diversified. You would have to invest in several non-diversified funds to achieve diversification and reduce certain risks.
Mutual funds are managed by investment professionals, who have the knowledge and expertise to buy and sell securities that fit the investment objectives of the fund. Most fund managers have extensive educational and professional credentials and years of experience managing money.
For an individual investor, buying and selling individual stocks or bonds can be complicated, requiring extensive knowledge of financial markets; expensive, because of brokerage costs; and time consuming. Mutual funds greatly simplify the investment process by providing you a ready-made professionally managed portfolio at a reasonable cost. Mutual fund shares can also be readily bought and sold at a price calculated daily, known as the Net Asset Value per share (NAV). Some mutual funds charge a "load" or sales charge to invest (a "front end load") or sell your shares ("back end load").
All Domini Funds offer both “load” and “no-load” shares. Each fund’s “investor shares” are "no-load," meaning that there is no fee charged to invest in the fund or to sell your shares. Although the Domini Funds' Investor shares are no-load, certain fees and expenses apply to a continued investment, as described in the Funds' current prospectus.
Investors can allocate their money among three major asset classes -- stocks, bonds, and cash -- and numerous subcategories within those asset classes.
Asset allocation is important because it determines how risky an overall portfolio is. If all of a portfolio's assets are concentrated in one area, such as stocks, it is likely to be more risky than a portfolio whose assets are spread out among diverse investment categories.
An asset allocation appropriate to an investor's goals and time horizon provides the best chance that an investor will meet his or her financial goals. In addition, an investor should examine his or her overall financial resources and personal ability to tolerate risk when making asset allocation decisions.
Investment Goals and Time Horizons
People invest for a variety of reasons. Some want to buy a new car next year; others are saving for a down payment on a house that they plan to buy three years from now. College tuition looms on the horizon for many families, and of course, there is retirement, which is the biggest investment goal for most individuals.
All investment goals have a time horizon, which is the length of time between now and when the money being invested will be spent. For example, if you are saving to buy a new car next year, your time horizon would be a short one. If you are saving for a down payment on a house, your time horizon might be medium-term, say three years. If you are currently 40 years old and saving for retirement, you have a long-term time horizon of about 25 years. Over time, of course, long-term goals such as retirement or funding your child's college education will become medium- and short-term goals. As your time horizon shifts, your asset allocation should shift accordingly.
For the most part, investments offering the greatest growth potential also pose the greatest risk. An investor with a short time horizon might want to minimize or avoid higher risk investments such as stocks or stock funds, because the growth potential offered by these investments over time can be offset by short-term volatility. If your time horizon is sufficiently short, say three to five years, you may wish to concentrate on more stable investments such as bond funds, or even money market accounts.
While bond funds offer no guaranteed rate of return, they are generally less volatile than stocks and usually offer greater returns than money market accounts or other cash equivalents. Those with a longer time horizon can generally afford to invest more aggressively because short-term volatility will usually be overcome by long-term growth. For long-term investors, the growth potential offered by stocks tends to offset the effects of inflation.