Mutual funds are one of the most widely held investments in the world — most 401k plans consist almost entirely of them. Yet most people couldn’t explain what one actually is. Here’s the plain-English version.
What a mutual fund is
A mutual fund pools money from many investors and uses it to buy a collection of assets — typically stocks, bonds, or both. When you invest in a mutual fund, you’re buying a share of that pool. The fund is managed by a fund company that handles all the buying and selling of underlying assets.
The idea: instead of buying individual stocks yourself (which requires significant capital and research), you buy into a fund that owns hundreds of stocks at once. Instant diversification, professionally managed (or passively tracked in the case of index funds).
Active vs passive mutual funds
- Actively managed funds: A fund manager and team of analysts pick stocks they believe will outperform the market. These charge higher fees (typically 0.5–1.5% annually) and over long periods, roughly 85–90% of them underperform their benchmark index.
- Index mutual funds: Passively track a market index — they just buy everything in the S&P 500 or total market, in proportion. Very low fees (as low as 0% at Fidelity). No stock picking, no manager risk.
How mutual funds differ from ETFs
- Trading: Mutual funds trade once per day at closing price. ETFs trade throughout the day like stocks.
- Minimums: Some mutual funds have minimum investments ($1,000+). ETFs typically have no minimum beyond one share price.
- Automation: Mutual funds are easier to automate — you can invest exactly $200/month. ETFs are trickier due to fluctuating share prices (though fractional shares at most brokerages have largely solved this).
Which should you use
In a 401k: you’ll typically choose from the mutual funds offered by your employer’s plan. Pick the lowest-cost index funds available — usually labeled things like “S&P 500 Index Fund” or “Total Market Index Fund.” Avoid the actively managed options with high expense ratios.
Outside a 401k: either index mutual funds or ETFs work. Both Fidelity’s zero-fee mutual funds (FZROX, FZILX) and Vanguard’s ETFs (VTI, VXUS) are excellent choices with near-identical outcomes.