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Investing FundamentalsChapter 3 — Understand Mutual Funds

3-1 What Is a Mutual Fund?

A page setting out a mutual fund as a way of holding several assets together

When people start thinking about regular contributions through a tax-advantaged account, a mutual fund is usually the first thing they meet. The first thing to settle is that a mutual fund is not a product where you pick one company — it is a product that makes it easier to hold many equities or bonds together.

What you'll learn
  • A mutual fund makes it easy to hold several assets together.
  • You can diversify from a small amount without picking companies one by one.
  • Unlike an individual share, you look at the mix inside rather than one company's merits.
  • Holding a fund does not give you shareholder perks or voting rights in the companies it invests in.

1. A mutual fund holds several assets together

A mutual fund pools money from investors, runs it as one pot, and holds a range of equities, bonds, and other assets within it. The big advantage is that a single product can spread widely without you buying dozens of companies yourself.

A mutual fund is a basket you hold in one go
It pools money from investors and runs it across equities, bonds, REITs, commodities, and more.
Investor AInvestor BInvestor CMutual fundEquity AEquity BGov. bondsCorp. bondsREITGoldOne product holds a range of assets together

2. How is the price set? NAV and total net assets

What corresponds to a fund's price is its NAV (net asset value per unit). The combined value of the equities, bonds, and other assets inside is called total net assets, and dividing that by the total units held by all investors gives the NAV per unit. If the assets inside rise, the NAV rises; if they fall, it falls.

What NAV is — a fund's price per unit
NAV is the total of a fund's assets (total net assets) divided by the units held by all investors. It rises as the holdings grow and falls when money leaves through distributions.
A mutual fund pools everyone's money and runs it togetherThe pooled total is “total net assets”; divided into one unit it becomes the “NAV”Equities¥55.0mBonds¥30.0mCash & equivalents¥15.0mAssets the fund holds (total net assets) = ¥100mDivide that by the units held by all investors…Investors1,500 units2,500 units2,000 units3,000 units1,000 units10,000 units in total¥100m ÷ 10,000 units =NAV ¥10,000(per unit)If the holdings inside rise the NAV rises; if money leaves through distributions it falls

Unlike a share price, NAV does not move in real time. It is normally calculated once a day after the market closes and published the following business day. So both when buying and when selling, your trade completes only after the value of the holdings for that day is fixed — a significant difference from an individual share.

3. Well suited to a first step into diversifying, but you still need to look inside

A mutual fund suits people who want to start broadly diversified, or who cannot spend much time researching individual companies. It is also easy to set up as an automated monthly contribution. But convenient does not mean anything will do. Choose on popularity without looking inside and you may end up holding something quite different from what you actually wanted.

A mutual fund becomes a different product depending on what is inside
A basket of equities, a basket of bonds, or a mix. Under the same label “mutual fund”, the risk and return character varies a great deal.
Equity typee.g. a global equity fundEquities 100%Large swingsBalanced typee.g. an equity and bond mixEquities 50%Bonds 45%5%Medium swingsBond typee.g. a domestic bond fundBonds 90%10%Small swings

Under the same label "mutual fund", one packed only with equities, one centred on bonds, and one mixing both are entirely different in both the range of movement and the return you can expect. Deciding I will buy a mutual fund is not enough — checking a basket of what? is what choosing by what is inside actually means.

2-5 How to Read Dividends

A page sorting out the difference between dividend yield, yield on cost, and payout ratio

3-2 Index and Active

A page separating index funds from active funds by whether they aim for the market average or leave it to a manager to beat it

On this page

1. A mutual fund holds several assets together2. How is the price set? NAV and total net assets3. Well suited to a first step into diversifying, but you still need to look inside