How mutual funds work and where to buy them

A mutual fund is a pool of money from many investors that a professional manager uses to buy stocks, bonds, or other securities. When you invest in a mutual fund, you own a share of that pool. The fund's value rises or falls based on what the manager buys and how those investments perform.

You buy mutual funds through a brokerage account — an account you open with a financial company that holds your money and executes trades. Common brokerages include Fidelity, Charles Schwab, Vanguard, E*TRADE, and Merrill Edge, though many banks also offer brokerage services. You deposit cash into your account, then use that cash to purchase mutual fund shares at their current price.

The price of a mutual fund share, called the net asset value (NAV), is calculated once per day after the market closes. If you place an order to buy during the trading day, your purchase executes at that day's closing NAV, not at the price you saw on your screen. This is different from stocks, which trade throughout the day at changing prices.

Key Takeaways

  • You buy mutual funds through a brokerage account by depositing cash and placing an order, with the purchase executing at the fund's daily closing price.
  • Mutual funds charge fees called expense ratios, typically ranging from under 0.1% to over 1% annually, which reduce your returns over time.
  • Active funds employ managers who pick individual securities; index funds track a market benchmark and usually cost less.
  • You can hold mutual funds in a regular taxable brokerage account or inside a tax-advantaged account like an IRA or 401(k).
  • Mutual funds distribute capital gains and dividends to shareholders, which may trigger taxes even in years when the fund's value falls.

Opening a brokerage account and depositing money

To open a brokerage account, visit a brokerage's website or app and complete their account process. You will provide your name, address, Social Security number, employment information, and banking details. The brokerage verifies your identity and approves the account, usually within one business day.

Once approved, you link a bank account and transfer money into your brokerage account. This transfer typically takes three to five business days. Some brokerages offer expedited transfers for a fee, or allow you to deposit by check. Until your money arrives, you cannot purchase mutual funds.

Most brokerages do not charge a fee to open an account or hold cash in it. However, some require a minimum deposit to start — this ranges from zero to several thousand dollars depending on the brokerage and account type. Check the brokerage's website for its current minimums before you explore.

Choosing between active and index mutual funds

An active mutual fund employs a manager or team that researches securities and decides what to buy and sell. The manager aims to outperform a market benchmark — for example, beating the S&P 500. Active funds charge higher fees because they pay for research and trading activity.

An index mutual fund tracks a specific market index by holding the same securities in the same proportions. For example, an S&P 500 index fund holds all 500 companies in that index. Index funds require less management, so they charge lower fees. Over long periods, most active funds underperform their index benchmarks after fees are subtracted.

Your choice depends on what you believe about market efficiency and how much you want to pay. Index funds offer lower costs and predictable performance tied to the market. Active funds offer the possibility of outperformance, but charge more and historically deliver it rarely. Both are legitimate choices; the difference is cost and philosophy, not safety.

Understanding mutual fund fees and expenses

Every mutual fund charges an expense ratio — an annual percentage of your investment that covers the fund's operating costs. This fee is deducted automatically from the fund's value each day, so you do not write a check. A fund with a 0.5% expense ratio costs you $5 per year for every $1,000 invested.

Expense ratios vary widely. Index funds typically charge 0.03% to 0.20% annually. Active funds often charge 0.5% to 1.5% or higher. Over decades, this difference compounds significantly. A $10,000 investment in a fund charging 0.10% grows differently than the same investment in a fund charging 1.0%, even if both funds hold identical securities.

Some brokerages also charge transaction fees when you buy or sell a mutual fund — typically $5 to $50 per trade. However, most major brokerages have eliminated these fees for their own mutual funds and for many third-party funds. Check your brokerage's fee schedule before you buy.

You may also encounter a sales load, which is a commission paid to the broker or advisor who sold you the fund. Loads range from 2% to 6% of your investment. You can avoid loads entirely by buying no-load funds directly from the fund company or through a discount brokerage.

Tax treatment of mutual fund distributions

Mutual funds distribute income to shareholders in two forms: dividends (from stocks or bonds held by the fund) and capital gains (from securities the fund sold at a profit). These distributions are taxable in the year they occur, even if you reinvest them back into the fund.

The tax rate depends on the type of distribution and how long you held the fund. may have access to dividends and long-term capital gains (from securities held over one year) are taxed at lower rates than ordinary income. Short-term capital gains are taxed as ordinary income. Your brokerage sends you a Form 1099-DIV each January showing all distributions from the previous year.

This tax treatment applies only to mutual funds held in a regular taxable brokerage account. If you hold mutual funds inside a tax-advantaged account — such as a traditional IRA, Roth IRA, or 401(k) — distributions are not taxed until you withdraw money from the account (or never, in the case of a Roth IRA). Many investors hold mutual funds in these accounts to defer or avoid taxes on distributions.

Placing your first mutual fund purchase

Once your brokerage account is funded, log into your account and navigate to the "Buy" or "Trade" section. Search for the mutual fund by its ticker symbol — a four-letter code ending in "X" for most mutual funds. For example, VTSAX is Vanguard's Total Stock Market Index Fund.

Enter the number of shares you want to buy or the dollar amount you want to invest. The brokerage shows you the current NAV and calculates how many shares your money will purchase. Review the fund's expense ratio, holdings, and performance history before confirming. Once you submit the order, it executes at that day's closing NAV.

Your mutual fund shares appear in your account the next business day. You can then hold them, add to them with future deposits, or sell them whenever you choose. There is no lock-in period — you own the shares outright and can liquidate them at any time, though selling may trigger capital gains taxes if held in a taxable account.

Holding mutual funds in retirement accounts

Many investors buy mutual funds inside retirement accounts because the tax treatment is more favorable. A traditional IRA allows you to deduct contributions from your taxable income (subject to income limits if you have a workplace 401(k)), and you pay taxes only when you withdraw money in retirement. A Roth IRA offers no upfront deduction, but withdrawals in retirement are tax-free.

A 401(k) is a workplace retirement plan where you contribute pre-tax money, and your employer may match a portion of your contributions. Many 401(k) plans offer a menu of mutual funds to choose from. You cannot buy any mutual fund you want in a 401(k) — only those the plan sponsor has selected.

Contribution limits differ by account type and change annually. For 2024, you can contribute up to $7,000 to an IRA (or $8,000 if you are 50 or older) and up to $23,500 to a 401(k) (or $31,500 if 50 or older). These limits explore across all IRAs or 401(k)s you own, not per account. Holding mutual funds in these accounts is one of the most common ways individual investors build long-term wealth.

Frequently Asked Questions

What is the minimum amount I need to invest in a mutual fund?

Most mutual funds have no minimum investment if you buy through a brokerage. Some funds sold directly by the fund company require a minimum of $1,000 to $3,000 for the initial purchase, though subsequent investments may have lower minimums. Your brokerage may have its own minimums, but most major brokerages allow you to buy any amount of a mutual fund.

Can I lose money in a mutual fund?

Yes. Mutual fund values fluctuate based on the performance of the securities they hold. If the stocks or bonds in the fund decline in value, your investment declines too. However, mutual funds are diversified — they hold many securities — so the risk is typically lower than owning a single stock. The longer your time horizon, the more time you have to recover from temporary declines.

Should I reinvest my mutual fund distributions or take them as cash?

From a tax perspective, reinvesting and taking cash are equivalent in a taxable account — both trigger the same tax bill. Reinvesting is often simpler because most brokerages do it automatically, and it compounds your returns over time. In a retirement account, reinvesting is usually the default and makes sense because there is no tax consequence either way.

How often should I buy mutual funds?

This depends on your financial situation and goals. Many investors buy mutual funds regularly through automatic monthly or quarterly transfers from their bank account — a strategy called dollar-cost averaging. Others make lump-sum purchases when they have cash available. Both approaches work; the key is consistency and staying invested over many years.

What happens if the mutual fund company goes out of business?

Your mutual fund shares are held in your brokerage account, not by the fund company itself. If a fund company closes a fund, your shares are either transferred to another fund or liquidated and the proceeds deposited into your account. Your brokerage account is also protected by SIPC (Securities Investor Protection Corporation) up to $500,000 per account, which covers losses from brokerage failure, not market losses.