What is a Mutual Fund? A Simple Guide for Teens
There is a reason investing doesn't show up until Lesson 14 in Beyond Personal Finance. Investing can be exciting, but before teens learn what to invest in, they need to understand how to have money available to invest in the first place (hint: earn more than you spend). We can spend a lot of time teaching teens which investments might make them money, but none of it matters if they develop a lifestyle that consumes every dollar they earn. So, we give them 13 lessons to lock that important concept down before we move on to investing.
Teens can be tempted to view the stock market like a real-life video game, where the goal is to pick the right stock, watch the price move, and know when to buy or sell. But successful long-term investing is usually much less exciting. Time and diversification are the real workhorses. A mutual fund is an investment vehicle designed to put that strategy into practice by spreading money across many investments and allowing it to grow over time.
Mutual funds is a term mentioned all the time, but rarely explained. This piece breaks down what they are, how they work, and why they matter. Give it to your teen, then ask them over dinner tonight what they learned.
What is a Mutual Fund?
A mutual fund is actually a pretty simple concept. It takes money from many different investors, pools it together, and uses that money to buy a collection of investments. Those investments might include stocks, bonds, or a combination of both.
Imagine you have $500 to invest. You could put all $500 into the stock of one company. If that company does well, your investment may do well. But if the company struggles, all of your money is tied to that one investment.
A mutual fund spreads that risk around. Instead of owning stock in just one company, you invest in a fund that may own shares in dozens, hundreds, or even thousands of companies. When you invest in a mutual fund, you buy shares of the fund rather than directly purchasing each of the individual investments it holds.
This is diversification. Think of it as the investing version of not putting all your eggs in one basket. One company can have a terrible year without taking your entire investment down with it. But the tradeoff works the other way too. If one company in the fund has an incredible year and its stock price takes off, you won't get the same benefit you would have if all your money had been invested in that company. Diversification means giving up some of the potential home runs in exchange for reducing the damage from the strikeouts.
Of course, diversification doesn't mean you can't lose money. If the overall market falls, the value of a mutual fund can fall too. But your financial success isn't riding on the performance of a single company.
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Not All Mutual Funds Are the Same
Knowing that something is a mutual fund doesn't tell you what is actually inside it. One mutual fund might own stocks from hundreds of large U.S. companies. Another might focus on small companies, international companies, technology stocks, bonds, or some combination of investments.
That means two mutual funds can perform very differently and carry very different levels of risk. A fund made up primarily of stocks will behave differently from one made up primarily of bonds. And a fund concentrated in one industry won't provide the same level of diversification as one spread across many industries and companies.
So before investing in a mutual fund, you need to know what the fund actually owns. Fortunately, mutual funds provide plenty of information about what they invest in, how they are managed, what they charge, and how they have performed. We’ll look at where to find that information and, more importantly, how to make sense of it in a minute.
One of the most common strategies is simply to follow a market index. These are called index funds, which I covered in detail in Investing for Teens: Why Index Funds Are a Great Place to Start. For now, the important thing to understand is that “mutual fund” doesn't tell you what you're invested in. You still need to look under the hood.
How to Dig Deeper
So how do you “look under the hood” and find out what is actually inside a mutual fund? Start with its ticker symbol, a short combination of letters used to identify the fund. Type that symbol into the website of the company that manages the fund or an investment research website, and you'll find a page filled with information about it.
At first, that page can look like a wall of numbers and investing jargon. You don't need to understand all of it. A few key pieces of information will tell you a lot about the fund:
Start with what the fund owns. Look at the types of investments in the fund and its largest holdings. If it is a stock fund, you may also be able to see how the money is divided among industries such as technology, healthcare, financial services, and energy. This gives you a much better idea of how diversified the fund really is.
Next, look at its performance. You'll usually see how the fund has performed over several periods, such as one year, five years, and ten years. Don't make the mistake of simply finding the fund with the highest recent return. A great year tells you what happened in the past, not what will happen next. Looking at longer periods gives you a better picture of how the fund has performed through different market conditions.
Then look at what it costs. Mutual funds charge fees to cover the cost of operating the fund. One of the most important numbers to find is the expense ratio, which tells you what percentage of your investment goes toward those expenses each year. An expense ratio of 0.50%, for example, means about $5 per year for every $1,000 invested. That may not sound like much, but fees matter more as your investment grows and you hold it for many years.
Finally, look at risk. A fund that invests mostly in stocks will generally carry more risk than one that invests mostly in bonds, and a fund concentrated in a particular industry may carry more risk than one spread across many industries. The goal isn't to find an investment with no risk. That doesn't exist. The goal is to understand the risk you are taking before you put your money into it.
Every mutual fund also has a document called a prospectus. Think of it as the fund's official guidebook. It contains more detailed information about the fund's goals, investments, risks, and fees. You don't need to read every page, but you should know what it is and where to find it. That may still feel like a lot to sort through, especially when you are just getting started. The good news is that investing isn't something you have to figure out entirely on your own. In the next section, we'll look at where you can turn for help.
Get Help
If you're under 18, investing is not something you can do entirely on your own. You'll generally need an adult to open and manage a custodial account for you, or, if you have earned income, a custodial Roth IRA. That adult may also be one of your best resources for learning how investing works.
Start by asking a parent, grandparent, or another trusted adult about their own experience. What do they invest in? How did they choose those investments? What have they learned along the way? If they're willing, ask them to pull up one of their investments and walk you through it. You can learn a lot by seeing how someone you trust actually puts these concepts into practice.
Your family may also work with a financial advisor. An advisor can help you understand different types of mutual funds, risk, fees, and the information you uncovered in your own research. But don't be afraid to ask the advisor questions, including how they get paid. Some advisors charge fees for their services, while others may earn commissions from certain investments.
Whether you're getting help from a family member or a professional, don't hand over the thinking along with the decision. You should still understand what you are investing in and why. It is your money, so even when someone is helping you, you should understand where it is going.
Investing doesn't have to be complicated or exciting to be successful. Understanding what you own, spreading your risk, and giving your money time to grow may not feel like playing the stock market, but that's the point. When it comes to long-term investing, diversify and wait.
Frequently Asked Questions:
What is a mutual fund in simple terms?
A mutual fund pools money from many investors and uses it to buy a collection of investments, such as stocks or bonds. When you invest in a mutual fund, you own shares of the fund rather than directly owning each investment inside it. This allows you to spread your money across many investments instead of relying on the performance of just one.Are mutual funds a good investment for teenagers?
Mutual funds can give teens exposure to many investments at once, making diversification easier than buying individual stocks one at a time. But not all mutual funds are the same. Before investing, teens should understand what the fund owns, its past performance, its fees, and the amount of risk involved.How can a teenager start investing in mutual funds?
If you're under 18, you'll generally need an adult to open and manage an investment account for you. This may be a custodial investment account or, if you have earned income, a custodial Roth IRA. Before choosing a mutual fund, learn what it invests in, what it costs, and how much risk you're taking. A parent, trusted adult, or financial advisor can also help you get started.
About Beyond Personal Finance: Beyond Personal Finance gives teens (middle & high school) the chance to design their future to see if they can really afford the life they dream of. In one semester (20 lessons- less than 2 hours per lesson), your teen will choose (and budget for) a career, car, apartment, spouse, house, investments, and so much more. This is the class your teen will get excited about. We also provide a curriculum called Before Personal Finance for tweens. Before Personal Finance is designed for late elementary students (Ages 8-12) and introduces foundational money concepts—spending, saving, investing, and borrowing—in a way that’s imaginative, hands-on, and fun. Learn about our full offering of services at beyondpersonalfinance.com!
