A mutual fund is a financial intermediary. Many people consider mutual fund as a company, this would be an over-simplification. It is more an investment vehicle that brings together a group of people interested in investing within a predefined objective.
The income produced through these investments plus the appreciation of capital, earned by the scheme, is shared among the investors, depending on the units possessed by them. If there is a loss or depreciation of capital then that too is shared among the investors participating in the fund.
These mutual funds charge a fees covering their service expense and other expenses incurred in the process of investing.
Advantages of a mutual fund
Diversification: Investing in a single security i.e. stock or bond can be risky, where as owning a mutual fund that holds numerous securities reduces risk significantly.
Professional management: It is difficult and time consuming to pick the best stocks and bonds for your portfolio. It requires continuous and sustained effort. Allowing a professional mutual fund manager to make decisions about stocks and bonds for you can save you time and frustration.
Minimal transaction costs: Buying individual stocks and bonds is expensive in terms of transactions costs. Each time an investor buys or sells, they have to pay a brokerage fees along with many other expenses. Since, the scale of purchases and sales are huge, the transaction cost for mutual funds are less.
Flexibility: Owning individual stocks and bonds does not allow for much flexibility in terms of liquidity, or the ability to access your money. Where as in a mutual fund, you can withdraw your investments in two working days.
Service: Mutual fund companies may also offer other services, including automatic investment and withdrawal plans; automatic reinvestment of interest, dividends, capital gains and help with taxes.
Transparency: Strict government regulations and high disclosure policy makes it a good investment option. This also makes it safe.
Disadvantages of a mutual fund
Performance: Generally, most actively managed mutual funds have not beaten their benchmarks over the long-term. While in some years actively managed funds outperform their index fund counterparts, there are times when its the other way round.
Risks: Mutual funds are subject to both market-related risks and asset-related risks, particularly in very concentrated portfolios, which are not as well diversified.
Professional management: Management is by no means infallible, and, even if the fund loses money, the manager still charges fees.