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What are Mutual Funds?

Mutual funds invest in a variety of stocks, bonds or other securities to meet a specific investment objective. But how do they make money?

How Mutual Funds Make Money

Mutual funds help mitigate risk through diversifying investments among a variety of asset classes and a variety within a single asset class (e.g., stocks from large, medium and small companies, international and domestic companies and different industries). Funds make money in several ways. They may earn dividends or interest on the investments they own; sell securities or charge fees and operating costs to the customer (that’s you.)

infographic explaining what mutual funds are

How Do I Know What I’m Investing in?

When your money is on the line, knowing how mutual funds make money is crucial. If they’re profitable because they are passing costs on to the investors through common investing fees, you’ll want to stay away. You can find information about the fund’s investment criteria, including goals and strategy, in the prospectus, which is the official booklet describing the fund. This booklet will help you pick funds that are right for you.

How to Buy Mutual Funds

Go to a broker, the website of a mutual fund company or an online brokerage. Minimum investments can be as low as $500. Always find out about commissions, expenses and common investing fees before you pick funds, as these can vary widely.

Advantages of Mutual Funds

Once you understand how mutual funds make money, you’ll be able to identify the good ones, which have three major advantages:
  • The first advantage of mutual funds is that a professional fund manager researches investment opportunities and conduct the actual buying and selling, taking the burden off of you.
  • Another advantage is that buying shares of a fund is more convenient than investing on your own in all the companies included in a fund’s holdings.
  • Finally, earnings are automatically reinvested for you, which increases the number of shares you own.

[Any reference to a specific company, commercial product, process or service does not constitute or imply an endorsement or recommendation by the National Endowment for Financial Education.]