What Is a Mutual Fund?
Point of Interest
Mutual funds allow you to benefit from investments in a variety of assets, without the need to make individual purchases. What is the best mutual fund for you will depend on your personal investment objective and risk preferences.
If you are looking to invest for your retirement or other long term financial goals, a mutual fund is an investment to consider. Mutual funds are one of the most popular investing tools as they offer considerable advantages, such as diversification benefits, professional management and lower fees. The best mutual fund for you will depend on your investment goals and risk appetite, but there are more metrics that will help you compare them before making the final decision.
The 8 Best Mutual Funds of 2020
- T. Rowe Price Institutional Large Cap Growth Fund: Best for large-cap growth
- Fidelity® Contrafund® Fund: Best for large-cap investments that generate capital gains
- Vanguard Equity Income Fund Provider: Best for large value investments
- The Vanguard Tax-Managed Capital Appreciation Fund: Best for the U.S. large blend investments
- T. Rowe Price Diversified Mid Cap Growth Fund: Best for mid-cap growth
- American Funds Capital World Bond Fund: Best for global fixed-income
- Vanguard LifeStrategy Income Fund: Best for the combination of income and capital appreciation
- Parnassus Core Equity Fund: Best for socially responsible investment
|Mutual Fund||1-Year Return||3-Year Return||Min. Investment||Expense Fee Ratio|
|T. Rowe Price Institutional Large Cap Growth Fund||18.83%||21.50%||$1 million||0.56%|
|Fidelity® Contrafund® Fund||21.28%||18.06%||$0||0.81%|
|Vanguard Equity Income Fund||15.73%||10.87%||$3,000||0.26%|
|The Vanguard Tax-Managed Capital Appreciation Fund||21.63%||14.5%||$10,000||0.09%|
|T. Rowe Price Diversified Mid Cap Growth Fund||24.68%||17.44%||$1 million||0.83%|
|American Funds Capital World Bond Fund||7.04%||4.33%||$250||0.95%|
|Vanguard LifeStrategy Income Fund||10.88%||6.16%||$3,000||0.11%|
|Parnassus Core Equity Fund||23%||14.29%||$2,000||0.86%|
What is a mutual fund?
A mutual fund is an investment company that pools money from many investors to invest it on their behalf in stocks, bonds and other assets. When you invest money into a mutual fund, you buy its shares, with each share representing your slice of ownership in the fund and the income it makes.
Before investing your money, there are several indicators that you may want to check, such as assets under management, net asset value and expense ratio.
Assets under management refer to the market value of all investments that a mutual fund holds. Net asset value refers to the mutual fund’s assets less its liabilities. This is what you will get or pay when you decide to sell or buy a share in a mutual fund. This value will typically fluctuate every day and is reported on the fund manager’s website.
An expense ratio, expressed as a percentage of the assets under management, is the annual fee that mutual funds charge their shareholders. These fees, disclosed in a fund’s prospectus under the heading “Shareholder fees,” currently tend to be below 1%. In addition, mutual funds may also charge fees each time you buy or sell the shares.
Based on the investment objective, mutual funds can be broadly divided into three categories:
- Growth funds’ investment objective is to achieve capital growth over the medium to long- term. They will invest primarily in stock with high growth potential.
- Income funds’ goal is to provide a regular and steady income to investors. They will invest primarily in fixed-income assets — government bonds, corporate debt, and money market instruments such as bank deposits. They are less risky compared to growth funds.
- Balanced funds’ investment goal is to achieve both moderate growth and regular income. These funds will typically invest both in equities and fixed-income securities in the proportion declared in their documents.
Mutual funds vs. exchange-traded funds
ETFs, aka exchange-traded funds, replicate a market index like the S&P 500 Index. However, unlike indexed mutual funds, which also replicate an index, ETFs are traded like stocks. This means that you can buy and sell its shares in the market. ETFs tend to have lower fees and usually don’t require a minimum investment, which is why it’s suitable for younger investors who are just starting out on their investment journey. However, many ETFs have a relatively high bid-ask spread, or the difference between the price at which you can sell and buy them, which may considerably cut into your returns.
Passively managed mutual fund vs. actively managed mutual fund
Passively managed mutual funds are those that track an index, which means that portfolio managers will only buy and sell securities to replicate the selected index. Due to this feature, they can charge lower fees compared to actively managed mutual funds, which tend to have more transactions and, consequently, higher transaction costs.
Unlike actively managed mutual funds, with passively managed funds your investment goal is not to beat the market, but rather to keep up with it. As Morningstar reports, actively managed funds have failed to beat their benchmarks, especially over longer time horizons. While a fund manager may outperform for a year or two, the outperformance does not persist, which makes passive funds a compelling investment for long-term investments such as saving for retirement.
Mutual funds vs. stock picking
If you are confident in your investment skills and ability to spot opportunities for returns while avoiding excess risks, you may consider investing in individual stocks or bonds. But, apart from requiring specialist skills, this strategy will also involve much higher risk as your portfolio will be more concentrated.
The 8 Best Mutual Funds of 2020
T. Rowe Price Institutional Large Cap Growth Fund: Best for Large-Cap Growth
This fund invests in large companies with strong growth in earnings and cash flow that can sustain this momentum even during periods of slow economic growth. These stocks do not necessarily move in tandem with the S&P 500 index, which was evident as the fund performed well during the financial crisis. Since its inception in 2001, this fund has consistently achieved higher returns compared to its Morningstar category average. Top sector holdings include health care, consumer discretionary, and technology. Compared to peers, the fund is unique as its top position is health care, while others have heavier technology composition. Over the past year, the fund’s return stood at 18.83%, and 21.50% over the past three years.
Fidelity® Contrafund® Fund: Best for Large-Cap Investments to Generate Capital Gains
Branded as the “largest solely managed active equity mutual fund in the world,” Fidelity® Contrafund® Fund focuses on investing in large-cap U.S. growth stocks to generate capital gains rather than income. The fund invests heavily in the financial sector, but also the tech sector. Launched in 1984 by one of the oldest mutual fund providers, the fund has achieved a 21.28% return over the past year, and 18.06% over the last three years.
Vanguard Equity Income Fund: Best for Large Value Investments
Vanguard Equity Income Fund invests in large-cap stocks that may be undervalued. Launched in 1988, the fund has achieved a 15.73% return over the past year, and 10.87% over the past three years, while its expense ratio stands at 0.26%, which Morningstar classifies as lower than its peers. The fund requires at least $3,000 as an initial investment.
The Vanguard Tax-Managed Capital Appreciation Fund: Best for the U.S. Large Blend Investments
This fund is fairly representative of the overall U.S. stock market with a portfolio balanced between value and growth. The fund requires a minimum initial investment of $10,000. The expense ratio stands at 0.09%, classified as low by Morningstar. The fund has returned 21.63% over the past year while achieving a 14.5% return over the past three years.
T. Rowe Price Diversified Mid Cap Growth Fund: Best for Mid-Cap Growth
T. Rowe Price Diversified Mid Cap Growth Fund focuses on mid-cap U.S. companies that are expected to grow faster compared to their peers. The U.S. mid-cap sector, which represents 20% of the total U.S. equity market, typically consists of companies with a market value between $1–$8 billion. The fund returned 24.68% over the past year, and 17.44% over the past three years. With the expense ratio at 0.83%, the fund requires a $2,500 initial investment.
American Funds Capital World Bond Fund: Best for Global Fixed Income
American Funds Capital World Bond Fund invests in fixed-income securities from around the world, with the U.S. still occupying the largest share. The fund has a bias toward the lower end of the investment-grade spectrum to boost returns while still curbing risk. The fund has returns that stand at 7.04% over the past year and 4.33% during the past three years — in line with the generally lower risk and return profile of bonds, but has a higher expense ratio at a solid 0.95%.
Vanguard LifeStrategy Income Fund: Best for Combining Income and Capital Appreciation
Vanguard LifeStrategy Income Fund invests in other Vanguard mutual funds aiming to achieve current income and some capital appreciation. The fund invests 80% in bonds and 20% in common stocks. Its indirect holdings are diversified across the short-term, intermediate and long-term U.S. and foreign government and corporate bonds; mortgage-backed and asset-backed securities and stocks. The fund has returned 10.88% over the past year, and 6.16% over the past three years, while the expense ratio stands at 0.11%.
Parnassus Core Equity Fund: Best for Socially Responsible Investments
Parnassus Core Equity Fund is a large- and mid-cap growth fund that specializes in socially responsible investments. With inflows to funds investing in companies with positive environmental, social and governance practices tripling over the past year, this type of mutual fund is increasingly attractive to investors. Not only does it offer investors an opportunity to invest in companies that share the same values, but it tends to provide healthy returns as well. Parnassus Core Equity Fund achieved a return of 23% over the past year and 14.29% over the past three years, with an expense ratio of 0.86%. Seeking capital appreciation and income, the fund aims to keep turnover low by investing in around 40 companies in which it has a strong conviction.