Definition

• Mutual funds are large pools of money that belong to a wide and diverse group of investors. The money pooled in these funds is managed by professional investors on behalf of contributors, who rarely have the time to follow the markets on a daily basis. The fund charges a relatively small fee, usually no more than a few percentage points, to compensate the professional managers for their services, pay for overhead expenses and hopefully turn a profit. The past annual returns of mutual funds are available in numerous publications, allowing investors to make better decisions on where to place their money.
  
  

Prospectus

• In order for investors to better assess whether a given fund is suitable for their financial goals, each mutual fund publishes a prospectus at the time of its launch. The prospectus outlines the investment objectives and limitations of the mutual fund and gives a broad idea about what kind of gains or losses investors can expect. The types of instruments the mutual fund will invest in, such as stocks, bonds and precious metals, and how monies will be allocated among these instruments is one of the issues explained in detail in the prospectus.
  
  

Risk

• The vast majority of mutual funds are not guaranteed, which is clearly explained in their prospectuses. In simpler terms, your investment in a mutual fund can grow or shrink depending on market conditions, the fund's strategy and the success of its management team. Because most funds invest in instruments such as stocks and corporate bonds, whose prices can go both up and down, the amount of money in a mutual fund can increase or decrease as well. Even if a particular mutual fund has never shown a loss in its history, depreciation of capital is always a possibility in a conventional mutual fund.
  
  

Guaranteed Funds

• Although most mutual funds cannot provide an explicit guarantee that your investment will appreciate, a limited number of specially structured funds are guaranteed not to lose value. These funds invest most of their assets in guaranteed instruments that cannot depreciate, such as U.S. government bonds, and can therefore provide a guarantee of principal preservation, as declared in their prospectuses. Notice, however, that such funds make up a fairly small percentage of all available mutual funds and may not always be superior to conventional mutual funds, even for conservative investors.
  
  

Limited Upside

• In finance, risk and return go hand in hand. In order for a fund to guarantee your investment, it must take less risk and therefore limit its potential returns. An individual investor can assure complete capital protection by purchasing government bonds or putting his money in an FDIC-insured bank, but the returns realized as a result will inevitably be limited. Instead of picking only guaranteed mutual funds, a better alternative may be to put a portion of your money, which you cannot afford to lose, in treasuries or an insured bank account, and choose conventional mutual funds for the rest. This approach will provide a much bigger menu of funds from which to choose.