A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. While there is no legal definition of the term “mutual fund”, it is most commonly applied only to those collective investment vehicles that are regulated and sold to the general public. They are sometimes referred to as “investment companies” or “registered investment companies”. Hedge funds are not mutual funds, primarily because they cannot be sold to the general public.
In the United States, mutual funds must be registered with the U.S. Securities and Exchange Commission, overseen by a board of directors or board of trustees, and managed by a Registered Investment Advisor. Mutual funds are subject to an extensive and detailed regulatory regime set forth in Investment Company Act of 1940. Mutual funds are not taxed on their income and profits if they comply with certain requirements under the U.S. Internal Revenue Code.
Mutual funds have both advantages and disadvantages compared to direct investing in individual securities. Today they play an important role in household finances, most notably in retirement planning.
There are three types of U.S. mutual funds—open-end funds, unit investment trusts, and closed-end funds. The most common type, open-end funds, must be willing to buy back shares from investors every business day. Exchange-traded funds (ETFs) are open-end funds or unit investment trusts that trade on an exchange. Non-exchange-traded open-end funds are most common, but ETFs have been gaining in popularity.
Mutual funds are generally classified by their principal investments. The four main categories of funds are money market funds, bond or fixed income funds, stock or equity funds, and hybrid funds. Funds may also be categorized as index (or passively managed) or actively managed.
Investors in a mutual fund pay the fund’s expenses, which reduce the fund’s returns and performance. There is controversy about the level of these expenses.