Mutual funds are attractive to investors for many reasons. First, they offer the investor the ability to enjoy the benefits of investing in multiple companies. Second, investors may be able to purchase more shares of a mutual fund than of individual stock. Third, mutual funds offer investors the chance to diversify their holdings simply by the type of fund they own. Mutual funds have become increasingly popular over the past decade and a half. You can’t even turn on your television set without seeing an ad for a mutual fund company like Oppenheimer or Janus. But many people don’t understand what a mutual fund is, how it works, and what its advantages and disadvantages are. A good analogy for mutual funds is that they are like shopping malls. If you own one store and it goes bankrupt, you lose everything.

Whereas, if you own a shopping mall and one store goes bankrupt, you still have income flowing from all the other stores within the mall. That’s the way mutual funds are. By owning a mutual fund rather than the stock of one company, you are less likely to realize any major loss, should a company go out of business. So, if you own $10,000 of the common stock of XYZ Corporation and it goes bankrupt, you lose your investment. But, if you own $10,000 in the ABC Growth Fund, which has invested in shares of XYZ Corporation, and XYZ goes belly up, the value of your mutual fund decreases. But you won’t lose your entire investment because the risk is spread out.

WHAT IS A MUTUAL FUND?

Mutual funds are investment companies. There are three main types of investment companies:

1. Unit investment trusts. (Here the fund invests strictly in a fixed portfolio of securities.)

2. Those who sell face-amount certificates. (Here the company pledges to pay the investor a specified amount upon maturity or a surrender value if sold early.)

3. Management companies. It’s the management companies that are the commonly used of the three. While both closed-end and open-end (or mutual) funds fall under the heading of management companies, most people are familiar with the open-end fund.