What is a mutual fund?
Mutual funds pool money from many investors to purchase a broad range of investments, such as stocks, bonds, cash, or other types of securities. They’re an efficient way to begin investing and building a portfolio.
How a mutual fund works
Mutual funds can be an efficient, cost-effective way to invest. When you make an investment in a fund, you purchase shares of the fund, which means you own a portion of all of the underlying investments. A mutual fund can help provide built-in diversification, professional management, and ongoing supervision of the fund’s holdings—all important elements of a well-rounded investment program.
| Type |
How it works |
May be a good option for |
| Mutual fund strategies |
| Index fund |
Attempts to mimic the performance of a specific market index, such as the
S&P 500® Index or the
Wilshire 5000 Index. |
First-time and seasoned investors who want broad market exposure and lower fees than those offered by actively managed funds. |
| Actively managed fund |
Professional managers choose what they believe are the best investment opportunities, given a fund’s strategy, with the goal of outperforming a specific benchmark. |
Those who want a professional manager’s investing experience and skills. |
| Mutual fund offerings |
| Stock (or equity) fund |
Invests in U.S. and/or international stocks. These funds offer the potential for long-term growth and have varying risk levels. |
First-time and seasoned investors who have a longer-term horizon. |
| Bond fund |
Invests in either taxable or tax-free corporate, municipal, or government bonds. |
Those looking for income or those who want a more conservative alternative to equity funds. |
| Blended or balanced fund |
Invests in a mix of stocks and bonds with the goal of achieving both investment growth and income. |
First-time and seasoned investors seeking a more diversified solution. |
| Target-date or life-cycle fund |
May hold a mix of stocks and bonds, and automatically shifts its asset allocation as the date you need the money (when you retire, for example) draws near. The funds are built for investors who expect to start gradual withdrawals of fund assets on the target date, to begin covering expenses in retirement. The principal value of the funds is not guaranteed at any time. |
Retirement investing and automatic rebalancing. |
A risk management technique that mixes a wide variety of investments within a portfolio. Historically, a portfolio of different kinds of investments has, on average, yielded higher returns and posed a lower risk than one made up of similar investments.
Market Value is the price of the company’s shares times the number of shares outstanding.
How sectors are divided: Within the main 10 sectors are 67 industries, such as food and drug, retailing, banks, oil and gas producers, and building products.
Fixed APY is the amount of interest paid in equal payments (based on a yearly interest rate on the principal) for the term of the cash investment.
The S&P 500 (or Standard & Poor’s 500) is an index of 500 stocks chosen for market size, liquidity, and industry grouping (among other factors). The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of stocks for major large companies.
The Wilshire 5000 Index is a market capitalization–weighted index, which means that it weighs the total dollar value of a company’s outstanding shares (overweighting companies with a higher firm value and underweighting those with a lower firm value). Originally composed of 5,000 stocks, this index is now composed of stocks from more than 6,700 publicly traded companies that meet the following criteria:
- The companies are headquartered in the United States.
- The stocks are actively traded on the American Stock Exchange.
- The stocks have pricing information that is widely available to the public.
Top Questions
Most investors choose mutual funds because they can offer a level of diversification and convenience. It can be a full-time job to determine your own portfolio’s asset allocation, research individual stocks, and find companies that are attractively priced or positioned for growth, all while keeping an eye on the financial markets. Mutual funds are professionally managed, so you can avoid the day-to-day decision making that investing requires. In addition, buying and selling individual stocks or bonds may become expensive for an individual investor over time. With a mutual fund, the costs of trades are spread over all investors in the fund.
The value of every individual security—a stock or a bond—is priced on a daily basis. Since a mutual fund is a basket of securities, the price of each of its underlying holdings may change value daily. As a mutual fund investor, you own shares of the fund. Each share represents proportional ownership of the fund, and based on the number of shares you own, you may earn a certain amount of income and/or capital gains that the fund generates from its investments.
There are three ways for you to make money in a fund. The fund may earn income from dividends on stocks and interest on bonds, which is passed along to shareholders. In addition, if a fund sells securities that have increased in price, it has a capital gain that’s paid out in the form of a distribution. Finally, if a fund’s share price, or net asset value (NAV), increases during the time you own it and you sell your shares, you earn a profit.
As with all investments, mutual funds do carry risks. Because stock and bond markets fluctuate daily, the prices of a fund’s underlying securities may change daily too. If the value of the fund’s underlying securities declines during the time you own it, the fund’s share price (or NAV) will decline, potentially causing you to lose principal if you sell the fund.
The cost to purchase and own a mutual fund can vary significantly depending on many factors, including the type of fund, the fund manager’s investment strategy, and what types of securities the fund may hold. The expense ratio is the cost for a fund company to manage and operate a mutual fund and is stated as a percentage of the fund’s assets. A fund company may also charge a fee or a sales charge to buy or sell the fund, and such fees are charged directly to fund investors. However, many funds are offered with no transaction fees and no loads, meaning that you do not pay a fee or sales charge to buy a fund.
offers thousands of funds from hundreds of well-established fund families with no loads and no transaction fees.
There are many ways to buy mutual funds. For instance, your company may offer a retirement plan, such as a 401(k), with mutual funds on its menu of investment options. If you are investing outside of your company-sponsored retirement plan, there are many mutual funds that you can purchase directly from the fund company. You can also buy funds through a supermarket, which typically offers thousands of funds from many different mutual fund providers. This broadens the number of alternatives for building and diversifying your mutual fund portfolio.
Yes, mutual funds can be a smart investment for many types of retirement accounts, including an IRA. Once you decide that opening an IRA is right for you, the next step is choosing the type of fund in which you want to invest. If you have a long time horizon until retirement and are comfortable taking on some risk for higher return potential, you may want to consider a stock (equity) fund for your IRA.
What is an ETF?
An ETF, or exchange-traded fund, is a single investment that generally holds a basket of securities (such as stocks, bonds) and trades like a stock. It can offer built-in diversification similar to an
, but it differs in that you can buy or sell shares anytime throughout the trading day.
How an ETF works
When you own an index ETF, you own a single investment representing a basket of chosen securities (such as stocks and bonds) that typically tracks to an index. The value of the ETF fluctuates with the value of the underlying index. In that sense, an index ETF is similar to an index mutual fund, but
.
Top Questions
Actually, ETFs and mutual funds are similar in many ways. ETFs are most like index mutual funds, since both ETFs and index mutual funds track indexes and offer exposure to a specific part of the market. ETFs are usually passively managed, so costs tend to be lower (as with index mutual funds) than those for actively managed investments.
But there are
. ETFs can offer investors access to more unique segments of the market than mutual funds do. And ETFs trade on an exchange like stocks, so you can buy or sell them at any time during the trading day.
Once you’re ready to trade an ETF:
- Consider placing a marketable limit order. This will help you balance both execution and price. When you are buying an ETF, this is a limit order where you specify a price equal to or greater than the posted offer price (but no higher than what you are willing to pay). That way, your order is likely to get filled immediately if the market doesn’t move, and you avoid the risk of paying far more than you intended.
- Be cautious about trading at market open or close. Markets can be unpredictable early and late in the day, and you may find yourself buying high or selling low. Also, consider when the markets for the underlying securities in the ETFs are open, especially if you’re trading international stock and bond ETFs.
- Get professional help with big orders. If you ever need to trade a substantial number of shares of ETFs (such as tens of thousands of shares), call us and we will connect you with specially trained traders. They may be able to have new shares created for you, which means you could enjoy better pricing.
Learn more about these and other best practices for trading ETFs. Download Trading Tips.
While ETFs can cost less than other investment types, there are still fees and expenses associated with them. Here's what you can expect to pay:
- Expense ratio: A percentage of the fund’s assets that is deducted annually to cover management fees and other costs.
- Trade commission: What you pay every time you buy or sell an ETF. Online trades of ETFs in Schwab ETF OneSource™ are commission-free when purchased through Schwab1, while trades of other third-party ETFs are subject to commissions. See Schwab’s commission schedule. Learn more about Schwab ETF OneSource™.
- The bid/ask spread: This is the difference (or spread) between the bid price (the highest price a buyer is willing to pay for a share) and the ask price (the lowest price a seller is willing to accept for a share). A wider gap means that more money goes to trading costs and less to the actual investment.
1. Conditions apply: Trades in ETFs available through Schwab ETF OneSource™ (including Schwab ETFs™) are available without commissions when placed online in a Schwab account. Service charges apply for trade orders placed through a broker ($25) or by automated phone ($5). An exchange processing fee applies to sell transactions. Certain types of Schwab ETF OneSource transactions are not eligible for the commission waiver, such as short sells and buys to cover (not including Schwab ETFs). Schwab reserves the right to change the ETFs we make available without commissions. All ETFs are subject to management fees and expenses. Please see for additional information.
There are more than 1,400 ETFs available. Schwab can help you find the right one for your portfolio.
- If you’re looking for commission-free ETFs, consider Schwab ETF OneSource™. You will find over 100 ETFs spanning major asset categories from leading ETF providers, with $0 online trade commissions through a Schwab account.1
- If you know what type of ETF you want—traditional (domestic, international, or bond), specialty, or sector—take a look at the ETF Select List™. This carefully compiled list represents our experts’ top ETF picks based on criteria that include cost of ownership, risk, fund structure, and how well the fund fits in its category. View the ETF Select List.
- If you’re looking for a specific ETF, consider using Schwab’s ETF Screener. You can select from a range of different criteria or use our predefined screens to filter the entire marketplace of more than 1,200 ETFs to find the one that’s right for you. Use Schwab’s ETF Screener.
- If you’re looking for exposure to a core asset category, Schwab ETFs™ offer some of the lowest expense ratios in their Lipper categories—and they trade online commission-free as part of Schwab ETF OneSource. Learn more about Schwab ETF OneSource.
- If you’re interested in creating an all-ETF portfolio yourself, try the Schwab ETF Portfolio Builder™. You can construct your own static portfolio based on your chosen risk profile using up to eight Select List ETFs. Learn more about the Schwab ETF Portfolio Builder.
1. Conditions apply: Trades in ETFs available through Schwab ETF OneSource™ (including Schwab ETFs™) are available without commissions when placed online in a Schwab account. Service charges apply for trade orders placed through a broker ($25) or by automated phone ($5). An exchange processing fee applies to sell transactions. Certain types of Schwab ETF OneSource transactions are not eligible for the commission waiver, such as short sells and buys to cover (not including Schwab ETFs). Schwab reserves the right to change the ETFs we make available without commissions. All ETFs are subject to management fees and expenses. Please see for additional information.
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What is a stock?
A stock is an ownership share in a corporation. As a company’s earnings improve, investors generally become more willing to buy the stock. Ultimately, stock investors hope to achieve gains in the form of dividends paid to stockholders (although not all stocks pay dividends) and in the form of capital gains.
Building and managing a portfolio of individual stocks takes a lot of time, effort, and money—which is why many investors find mutual funds or ETFs to be a more time-efficient and cost-effective solution.
How a stock works
When you buy a share of stock, you’re entitled to a small fraction of the assets (and dividends, if the company’s management chooses to pay them) of that company. The value of the stock is set by many people trading it in a free, open market—most often a stock exchange. The price of a stock fluctuates according to supply and demand, with many factors influencing these two broad aspects of stock prices.
| Size of stock |
Description |
| Large-cap |
The largest 14% of domestic companies in terms of
market value
|
| Mid-cap |
The next largest 42% of domestic companies in terms of capitalization |
| Small-cap |
The remaining 44% of companies in terms of capitalization |
| International |
Foreign (non-U.S.) companies |
| Global |
Foreign and domestic-based companies |
| Origin of stock |
Description |
| International |
Foreign (non-U.S.) companies |
| Domestic |
Companies based within the U.S. |
| Characteristics of stocks |
Description |
| Style |
Refers to whether a stock is a growth or a value (underpriced) investment |
| Sector and industry |
Stocks are usually divided into
10 sectors:
- Information technology
- Telecom services
- Utilities
- Health care
- Financials
- Industrials
- Consumer discretionary
- Consumer staple
- Materials
- Energy
|
Individuals cannot buy stocks directly from stock exchanges like the New York Stock Exchange. To buy stocks, start by opening a
Schwab account. The funds you deposit in the account can be used to make your purchases. You can then start to purchase and sell stocks, either via telephone or using the Schwab website. Or a Schwab representative can buy and sell stocks based on “orders” placed by you. Your broker will not do anything with your money unless and until you place an order that provides specific instructions about what you want done.
Not all. Many companies, particularly small or new ones, are privately held, meaning that they are owned exclusively by their founders and perhaps a few close associates. If a company is successful and needs more money to grow, it may decide to “go public,” meaning that the company offers stock to the public for the first time (an initial public offering, or IPO). Please keep in mind that IPOs are intended for those investors who have a longer time horizon and the ability to withstand potential price movements.
While stocks may have more ups and downs than many other investments, they have historically produced higher returns than those investments over the long term. In fact, over the past 30 years stocks have, on average, performed better than bonds, gold, and even cash
1—and there has never been a 20-year period when stocks, on average, have had a negative return.
2 As part of a long-term investment strategy that diversifies across multiple types of investments, some exposure to stocks may help fuel asset growth and potentially help you to meet your wealth-building goals.
1. Source: Zephyr StyleADVISOR.
2. Past performance is not indicative of future results.
Dividends refer to portions of a company’s earnings (the actual amount is determined by the company’s board of directors) that are distributed to shareholders. Many stable companies offer dividends to their stockholders. Keep in mind, though, that high-growth companies rarely offer dividends, because all their profits are reinvested to help sustain higher-than-average growth.
In some aspects, preferred stock is similar to a fixed income security (a bond). The amount of dividends paid to preferred shareholders is fixed, regardless of the company earnings. Preferred dividends may be omitted at the discretion of a company’s board of directors. In the event of a bankruptcy, preferred stock has priority access to the company’s assets over a common stock. However, preferred stock generally has limited or no shareholder voting rights. And some preferred stocks come with a “call provision” that allows the company that issued the preferred stock to repurchase and retire the stock, even though the owner may not wish to sell.
Yes.
Schwab Equity Ratings® provide easy-to-follow guidance, in the form of A/B/C/D/F letter grades, on approximately 3,000 domestic stocks and approximately 4,000 foreign stocks. A-rated stocks, on average, will strongly outperform, and F-rated stocks, on average, will strongly underperform, the equities market during the next 12 months.
What is a bond?
Cities, states, the federal government, and corporations issue bonds to raise capital for purposes such as building roads, improving schools, opening new factories, and buying the latest technology. When you invest in a bond, you become one of the bond issuer’s lenders. In fact, a bond is like an IOU—a promise from the borrower to pay back the money you’ve loaned, with interest.
How a bond works
Individual bonds typically pay a predefined schedule of
and promise to return your money on a specific maturity date (provided the issuer does not default).
Understand credit risk and how it may impact the value of a bond
| Type of bond |
Issued by |
May be a good option for |
Treasuries
(bonds, notes, and bills) |
Treasuries are issued by the U.S. government to pay for operations and fund the national debt. |
Investors who are looking to preserve principal and are willing to give up some potential yield for a higher credit quality investment. |
| Municipals or “munis” |
Municipal bonds are issued by state and local governments (and businesses owned by public authorities) to fund public projects. |
Investors in higher tax brackets or those looking to reduce taxable income. |
| Corporates |
Corporate bonds are issued by companies to fund operations or expansion. |
Investors who want to increase potential income and are comfortable with some potential credit risk. |
| Treasury Inflation-Protected Securities (TIPS) |
TIPS are issued by the U.S. Treasury and pay a return based on the rate of inflation. |
Investors who are looking to preserve principal and want to protect that principal from the effects of inflation. |
| Agencies |
Agency bonds are issued by either a government-sponsored enterprise (GSE) or a government-owned corporation. |
Investors who are looking to preserve principal and want liquidity and tax advantages along with the potential to earn a higher yield than that of Treasuries. |
| Mortgage-backed securities (MBS) |
MBS are issued by either a GSE or private mortgage lender. |
Investors who are comfortable with the risks and complexities of the products and are looking for regular income, as MBS pay both interest and a portion of principal on a monthly basis. |
Top Questions
Key differences between fixed income and stocks |
| |
Stocks |
Bonds |
| Investment Objectives |
Growth and to outpace inflation |
Stability, diversification, and income |
| Risk |
Higher. Principal values can be volatile. In the case of bankruptcy liquidation, stockholders receive their payment after bondholders and other creditors. |
Lower. Mainly includes interest rate, credit, and liquidity risks. |
| Income |
May or may not pay quarterly and special dividends |
Most pay a stated amount of interest to holders each year, typically semi-annually, sometimes monthly or quarterly. |
| Maturity |
Have no maturity date |
Most have a stated maturity date when principal is expected to be returned. |
| Ownership |
Ownership in the company; stockholders have voting rights |
No ownership; bondholders are considered creditors of the issuer and do not have voting rights. |
| Trading |
Trade through a centralized exchange, which consists of competing buyers and sellers |
Most bonds trade over the counter (OTC) or between bond dealers away from a central exchange. |
Individual bonds can help investors diversify their investments, save for the future, receive dependable income, and, in some cases, minimize taxes. Adding bonds to a stock portfolio can help lower the portfolio's volatility over time because stock and bond prices have historically tended to move independently and with different magnitudes at any given time. Therefore, if one asset class is underperforming, it does not mean the other necessarily will. Also, bonds typically have a stated maturity date when principal is expected to be returned, which can be useful for those trying to save money for a known future expense.
Bonds can be purchased as new issues in the primary market or as previously issued bonds in the secondary market. The primary market is where newly issued securities are sold to investors by the issuers (usually through bond dealers, called over-the-counter, or OTC, trading), which include the U.S. government, municipalities, U.S. government agencies, and corporations. When you buy a new issue in the primary market, you pay the new issue offering price, which is the same for all buyers. In the secondary market, previously issued bonds are traded between investors, including institutions.
Bond prices are often quoted as a percentage of the face value, which is generally $1,000 per bond. A bond priced at 90 can be thought of as 90% of face value, or $900.
- If a bond is trading in the market at less than face value (under par), it is said to be trading at a discount.
- If a bond is trading at more than face value (over par), it is trading at a premium.
There are several reasons bond prices may change; however, the two main drivers of price changes are the overall interest rate environment and changes in the assessment of a bond’s credit quality.
- Changing interest rates. Bond prices are sensitive to interest rates in the general economy and tend to move in the opposite direction. When interest rates fall, the price of a bond rises, and conversely, when rates rise, bond prices fall, all else being equal. Generally speaking, bonds with longer maturities are more sensitive to rate changes. Also, as a bond gets closer to maturity, the price of the bond moves closer to its face value.
- Changing assessments of credit quality. An upgrade or downgrade in a credit rating can affect a bond’s price and yield. Generally, a decrease (downgrade) in a bond’s credit rating will cause the bond’s price to fall because it is judged to be riskier, and an increase (upgrade) in credit rating usually causes a bond’s price to rise (all else being equal) because the market judges the bond to be more creditworthy.
Individual bonds typically pay a predefined schedule of fixed interest payments and promise to return your money on a specific maturity date (provided the issuer does not default).
Managing a portfolio of individual bonds can be more complex than investing in a bond fund. To manage effectively when principal comes due, you may need to find a replacement and/or reinvest interest payments over time. In addition, whereas bond funds are professionally managed, you are responsible for monitoring the individual bond risks, such as credit, liquidity, and interest rate changes.
Bond funds can be a way to own a diversified fixed income portfolio without having to select and manage a portfolio of individual bonds. Bond funds offer a variety of strategies from which you can choose, allowing exposure to a wide range of bond types, maturities, and levels of risk. However, income payments and principal values can fluctuate based on market conditions, and because bond funds never mature, there is no scheduled date to receive your principal back. To get it back, you’ll need to sell your shares, at which point they may be worth less than what you paid.
What are cash investments?
Options for investing your cash include certificates of deposit (CDs) and money market funds. With CDs, you choose a specific amount of time to invest your money, and at the end of that time period you receive your money back along with interest. Money market funds are mutual funds that hold a portfolio of high-quality, short-term investments. They pay a variable yield based on the performance of those investments.
How cash investments work
Cash investments provide a return in the form of interest payments. They are typically lower risk than other investment options, such as individual stocks or stock funds, but also typically offer a lower return.
What to consider before choosing a cash investment
Before choosing a cash investment, consider why you are holding the cash and how you plan to use it. Depending on what you plan to do with your cash, you may have specific preferences for liquidity, a fixed versus variable yield, and FDIC insurance.
| Type of cash investment |
How it works |
A good option for |
|
Liquidity |
Fixed or variable yield? |
FDIC-insured? |
| Certificates of deposit (CDs) |
When investing in a CD, you deposit a fixed sum of money for a specific amount of time, after which you get back your principal plus interest. Schwab offers a marketplace of CDs through Schwab CD OneSource®, allowing you to buy CDs from banks across the country through the convenience of one brokerage account. |
Investors who value FDIC insurance, principal protection, and a fixed rate of return and do not mind locking their cash up for a specific term2 |
Based on term |
Fixed annual percentage yield (APY)
|
Yes2 |
| Money market funds |
Money market funds are mutual funds that hold a portfolio of high-quality, short-term investments. Shares must be actively bought or sold just like other mutual funds. |
Investors who are seeking a competitive yield and next-business-day liquidity and who do not prioritize FDIC insurance |
Generally available on the next business day |
Variable (based on portfolio yield) |
No |
2. Funds deposited at an FDIC-insured institution are insured, in aggregate, up to $250,000 per depositor, per insured institution based upon account type, by the Federal Deposit Insurance Corporation (FDIC). The FDIC considers any other deposits you may have with an issuing bank. CDs you purchase from a particular bank are aggregated with any other deposits you may have with the issuing bank for determining FDIC insurance coverage (e.g., if you already have deposits of $250,000 with a bank, do not purchase CDs from the same bank in the same ownership category). Because the deposit insurance rules are complex, you may want to use the FDIC’s Electronic Deposit Insurance Estimator (EDIE) to estimate your total coverage at any particular bank.
Top Questions
Cash investments can still have a role in your investment mix, and can help reduce your exposure to risk, and as interest rates rise, returns on cash investments will likely rise too. Keeping a percentage of your portfolio in more liquid cash investments also allows you to take advantage of other investment opportunities as they arise.
Cash investments are basically interest-earning, lower-risk instruments, while the currency markets refer to the foreign exchange market, which is one of the most heavily traded and volatile markets in the world.
The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the U.S. government that insures all deposits at insured banks and savings associations, including checking accounts, savings accounts, and CDs, up to the insurance limit. Currently, the FDIC insurance limit is $250,000 per depositor, per insured bank, based upon ownership category (e.g., individual account, joint account).
CDs can be purchased through Schwab CD OneSource at your convenience, 24 hours a day, seven days a week. Other benefits include:
- Competitive rates and no fee—Schwab CD OneSource offers you a virtual one-stop marketplace for CDs, giving you access to some of the highest rates in the country, which you can easily compare by maturity and institution. Also, there are no hidden fees.
- Extended FDIC insurance—One way to increase FDIC coverage is to buy CDs from multiple banks through Schwab’s CD OneSource. All of the banks in Schwab CD OneSource are FDIC-insured.
- Choice and control—Because we screen CDs from hundreds of institutions throughout the U.S., you don’t have to comparison shop from bank to bank. Schwab CD OneSource offers you a selection of CDs, making it easy to search for the rate and maturity that meet your needs. Additionally, your CDs are held in your Schwab brokerage account, not at the issuing institution, allowing you to see your whole financial picture and manage your investments in one place.
An investment in a money market fund is neither insured nor guaranteed by the FDIC.
As you near retirement, there’s probably a greater chance that you will need more liquid investments, so it’s a good idea to consider how much you would like to spend in retirement and adjust your cash holdings appropriately.
