Mutual Funds Explained

A mutual fund is a pooled investment vehicle that collects money from many investors and invests it in a diversified portfolio of assets, such as shares, bonds, or a mix of both, managed by a professional fund manager on investors' behalf. Mutual funds remain one of the most widely used investment vehicles globally, forming the foundation of most retirement savings plans, workplace pensions, and retail investment portfolios, even as ETFs have grown rapidly as an alternative structure.

How mutual funds work

Investors buy shares or units in the mutual fund, pooling their money together with other investors, and the fund manager invests that pooled capital according to the fund's stated investment objective, whether that is tracking a broad market index, seeking income, or pursuing active growth through security selection. Each investor owns a proportional share of the overall fund, and the value of their holding moves with the fund's net asset value (NAV), calculated once per trading day based on the closing value of all the fund's underlying holdings. Unlike an ETF, which trades continuously during the day on an exchange, mutual fund orders placed during the day are all processed at that single end-of-day NAV, regardless of exactly when during the day the order was submitted.

Active versus passive mutual funds

Mutual funds fall broadly into two categories based on management style. Actively managed funds employ a portfolio manager (or team) who makes individual investment decisions aiming to outperform a relevant benchmark, charging higher fees to compensate for the research and decision-making involved. Passively managed index funds, by contrast, simply aim to replicate the performance of a specified market index at a much lower cost, since there is no need for active security selection. Decades of academic research and industry data have shown that the majority of actively managed funds underperform their relevant benchmark over long time horizons after fees, a finding that has driven substantial investor migration toward lower-cost passive index funds and ETFs over the past two decades, though some actively managed funds and strategies have persistently outperformed, making manager selection a genuinely difficult exercise for investors who do choose an active approach.

Fee structures

Mutual fund costs typically include an ongoing annual management charge, expressed as a percentage of assets under management, covering the fund manager's fee and other ongoing operating costs, often summarised in a single "total expense ratio" figure that allows investors to compare costs across different funds. Some funds, particularly those sold through financial advisers, have historically also charged upfront or exit sales charges, though regulatory reforms in many jurisdictions, including changes to adviser remuneration rules in the UK and EU, have reduced reliance on these upfront charges in favour of clearer, separately disclosed adviser fees.

Regulation and investor protection

Mutual funds sold to retail investors are subject to substantial regulatory oversight designed to protect investors, including rules on diversification, permitted investments, disclosure, and independent oversight of fund assets. In Europe, most retail mutual funds operate under the UCITS framework, which sets common standards for investor protection and allows funds authorised in one EU country to be marketed across the rest of the EU.

FAQ

Is a mutual fund the same as a pension?

No, though mutual funds are very commonly used as the underlying investment vehicle within a pension or retirement savings plan, which is itself a separate wrapper governing how and when the invested money can be accessed.

Can I lose money in a mutual fund?

Yes — a mutual fund's value moves with the value of its underlying holdings, so a fund invested in assets that fall in value will itself fall in value, and mutual funds are not guaranteed or insured against investment losses.

What is the minimum investment for a mutual fund?

This varies significantly by fund and provider, with some funds offering low or no minimum investment thresholds, particularly for funds accessed through workplace pension schemes or regular savings plans.

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Open-ended versus closed-ended funds

Most mutual funds are open-ended, meaning the fund continuously creates new units when investors buy in and cancels units when investors redeem, so the fund's total size expands and contracts with investor demand, and investors always transact directly with the fund itself at NAV. Closed-ended funds, by contrast, issue a fixed number of shares at launch, which then trade between investors on an exchange at whatever price the market sets, meaning a closed-ended fund's market price can trade at a premium or discount to the actual value of its underlying holdings, depending on investor sentiment toward the fund, unlike an open-ended mutual fund where investors always transact at NAV. This structural difference matters particularly for funds holding less liquid underlying assets, such as property or private equity, where an open-ended structure promising daily liquidity to investors can create a mismatch against genuinely illiquid underlying holdings, an issue that has led to high-profile suspensions of some open-ended property funds during periods of market stress when redemption requests outpaced the fund's ability to sell underlying property quickly enough to meet them.

Share classes and investor types

Many mutual funds offer multiple share classes within the same underlying fund, differing in their fee structure, minimum investment size, or currency denomination, allowing the fund provider to serve different investor segments, such as retail investors, institutional investors, or investors accessing the fund through a financial adviser, from within a single underlying pool of assets. Institutional share classes typically carry lower fees than retail share classes, reflecting the larger average investment size and lower servicing cost associated with institutional investors, while retail share classes may bundle in costs associated with investor servicing and distribution through intermediaries such as financial advisers or platforms.