What Is A Mutual Fund?

Summary

Ramsey Everyday Millionaires: What Is A Mutual Fund?

Host: Ramsey Network
Release Date: May 19, 2025

In the latest episode of Ramsey Everyday Millionaires, hosts Rachel Cruze and George Kamel delve into the intricacies of mutual funds, demystifying them for everyday investors. The discussion is both informative and engaging, providing listeners with a comprehensive understanding of mutual funds, their types, benefits, and how they can be a cornerstone of a robust investment strategy.

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Understanding Mutual Funds

The episode kicks off with Rachel Cruze addressing a common question, “What is a mutual fund?” She succinctly defines mutual funds as investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities (00:48). This collective approach allows individual investors to own shares in a broad array of companies, spreading risk and fostering stability in their investment portfolios.

George Kamel builds on this by explaining that when you invest in a mutual fund, you’re essentially buying shares of a collective portfolio (00:54). He emphasizes that with a single mutual fund, investors can hold tiny pieces of numerous companies—sometimes ranging from 90 to 200 firms—thereby achieving instant diversification.

“When you buy a piece of the fund, you're really buying a piece of these 200 companies.” — Rachel Cruze 00:56

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Benefits of Mutual Funds

Rachel underscores the primary advantages of mutual funds:

1. Instant Diversification: By holding a variety of stocks and bonds, the impact of a single company’s poor performance is mitigated by the strength of others in the fund (01:10).

2. Lower Costs: Mutual funds reduce the expense of trading individual stocks, making it more affordable for investors to participate in the market without incurring significant transaction fees (01:37).

3. Professional Management: Actively managed mutual funds employ a team of investment experts who continuously assess and adjust the fund’s holdings to optimize returns (01:37).

“Mutual funds make it really affordable to invest in a range of stocks without all these transaction fees.” — Rachel Cruze 01:37

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Types of Mutual Funds

George elaborates on the various types of mutual funds, categorizing them based on their investment strategies and objectives:

1. Growth Stock Funds: Focused on companies expected to grow significantly, these funds primarily invest in equities rather than bonds. They are ideal for investors seeking capital appreciation (02:06).

2. Index Funds: A subset of mutual funds, index funds are passively managed and track specific market indices like the S&P 500. They invest in the top companies within a given index without active selection (02:29).

3. Bond Funds: These funds invest in corporate or government bonds, offering regular interest income with lower market volatility. They cater to investors seeking stability and fixed income (03:00).

4. Money Market Funds: Comparable to high-yield savings accounts, money market funds invest in short-term debt instruments, providing high liquidity and minimal risk (03:21).

“Money market funds are almost like a high yield savings account… just going to sit there making a little bit of interest like a savings account.” — George Kamel 03:30

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How Mutual Funds Generate Returns

Rachel explains the mechanisms through which mutual funds generate returns for investors:

1. Capital Appreciation: As the values of the underlying stocks increase, so does the value of the mutual fund shares. Selling these shares at a higher price than the purchase value results in capital gains (04:12).

2. Dividends: Some companies distribute a portion of their profits to shareholders in the form of dividends. These can either be paid out to investors or reinvested to compound growth over time (04:11).

3. Reinvestment for Compound Growth: By reinvesting dividends, investors can harness the power of compound interest, significantly enhancing their long-term returns (04:18).

“That's what creates this amazing compound growth.” — George Kamel 04:18

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The Four Pillars of Mutual Fund Investing

George outlines the four primary categories of mutual funds recommended for a balanced investment portfolio:

1. Large Cap (Growth and Income): Comprising large, stable companies like Home Depot, these funds serve as the foundation of the portfolio, offering consistent performance without extreme volatility (05:00).

2. Medium Cap (Growth): These funds invest in medium to large-sized companies poised for growth, balancing stability with the potential for higher returns (05:38).

3. Small Cap (Aggressive Growth): Focused on smaller, high-growth companies such as tech startups, these funds offer significant upside potential but come with higher risk (05:38).

4. International: Investing in global companies like BMW, LG, and Samsung, international funds provide a hedge against domestic market fluctuations and exposure to diverse economies (05:51).

Rachel advocates for equal distribution across these four categories within retirement accounts, suggesting a 25% allocation to each. This strategy ensures diversification and balances risk and reward effectively.

“If you just choose those four funds in your 401k that have a long track record and have a solid return, you're going to be okay.” — George Kamel 06:22

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Practical Steps for Investors

As the episode concludes, Rachel encourages listeners to take proactive steps towards managing their investments. She recommends connecting with a SmartVestor Pro, financial advisors available through Ramsey Solutions, who can provide personalized guidance and education without making decisions on behalf of the investor.

“Connect with a SmartVestor Pro at ramseysolutions.com SmartVestor or click the link in the description...” — Rachel Cruze 06:28

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Conclusion

Rachel wraps up the discussion with a light-hearted remark, reinforcing the accessibility of mutual funds for everyday investors. The episode successfully breaks down complex financial concepts into understandable segments, empowering listeners to make informed investment decisions.

“I'm the Miss Rachel of mutual funds. You know, I try to just keep the cookies on the bottom shelf.” — Rachel Cruze 06:58

By demystifying mutual funds, Ramsey Everyday Millionaires equips listeners with the knowledge to build and maintain a diversified, cost-effective investment portfolio, paving the way toward financial independence and wealth accumulation.

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Key Takeaways:

• Mutual Funds pool investor money to purchase diversified portfolios of stocks, bonds, or other securities.
• Benefits include instant diversification, lower costs, and professional management.
• Types of Mutual Funds: Growth Stock, Index, Bond, and Money Market Funds.
• Returns are generated through capital appreciation, dividends, and reinvestment leading to compound growth.
• Investment Strategy: Allocate equally across Large Cap, Medium Cap, Small Cap, and International funds for a balanced portfolio.
• Action Step: Connect with a SmartVestor Pro for personalized investment guidance.

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Notable Quotes:

“When you buy a piece of the fund, you're really buying a piece of these 200 companies.” — Rachel Cruze 00:56

“Mutual funds make it really affordable to invest in a range of stocks without all these transaction fees.” — Rachel Cruze 01:37

“That's what creates this amazing compound growth.” — George Kamel 04:18

“If you just choose those four funds in your 401k that have a long track record and have a solid return, you're going to be okay.” — George Kamel 06:22

“I'm the Miss Rachel of mutual funds. You know, I try to just keep the cookies on the bottom shelf.” — Rachel Cruze 06:58

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For more insights and personalized investment advice, visit RamseySolutions.com and connect with a SmartVestor Pro today.

Transcript

[A]

Foreign. This episode is brought to you by SmartVestor. Connect with an investing pro near you at RamseySolutions.com SmartVestor what the heck is a mutual fund? Wouldn't you like to know? Well, Jay knows, but for the benefit of the group, a lot of people go, okay, I know Dave talks about that a lot. The good gross stock mutual funds.

[B]

Right?

[A]

That's a classic Dave line. But what is actually going on there? So let's talk about this. Mutual funds are investment vehicles that pool money from multiple investors, AKA you and me and Jade and me, to purchase a diversified portfolio of stocks, bonds, or other securities. So how do they work? So you're buying shares of a collective portfolio.

[B]

So you're buying. Wait, George. George.

[A]

A share.

[B]

George. I heard equities. I heard securities. I heard.

[A]

I'm just putting my glasses up for you.

[B]

Make it, make it. Put it on the bottom shelf for us.

[A]

All right, so shares are tiny pieces of a company, tiny pieces of ownership. Ah, so mutual. And let's say there's 90 to 200 companies within this one fund. And so when you buy a piece of the fund, you're really buying a piece of these 200 companies.

[B]

Amazing.

[A]

Got that, yeah. So investors, we all benefit from this diversification because we all know, oh, my gosh, Elon burped and Tesla stock went down 40%.

[B]

Right.

[A]

Well, we don't have to worry about that when there's 199 other stocks from other companies to balance it out.

[B]

So when you say that, you could have a fund that's got everything from Procter and Gamble to Pfizer to Coca Cola, Apple, Home Depot, all of that. All of those different stocks in one fund.

[A]

Exactly. So the benefits here, instant diversification. You have lower costs because trading single stocks can get expensive. Mutual funds make it really affordable to invest in a range of stocks without all these transaction fees because you're not doing these little nickel and diming transactions. And with an actively managed mutual fund, which is a lot of time, what we're talking about on the show, there's a team of investment experts that have come to together to decide which stock should go in here. And they're actively going, hey, should this one move out? Should this one move in?

[B]

And what are they trying to do when they do that?

[A]

Well, they're trying to get the best return for us, the investors. Yes. So that's the goal. So when you hear about, you know, a few types of mutual funds, for example, good growth stock funds. So what that means is these are equities to their stocks. These are not bonds, they're meant to grow. So we say good growth stock. These are companies that we expect to see some growth from.

[B]

That's right.

[A]

When you hear the word index fund, well that's really just a type of mutual fund. And what people are generally referring to is a passively managed mutual fund. So nobody's deciding what's in the fund. It's just taking the top 500 companies. So an S&P 500 index fund is just going to take the top 500 companies and buy those stocks?

[B]

That's right. And you could have different indexes. Yes. So we talk about the s and P500 a lot. That's kind of like the, the holy grail of indexes that people follow. But you might have heard of others.

[A]

Like nasdaq, Dow Jones.

[B]

Dow Jones.

[A]

See the ticker symbols up? So they're just different, you know, pools of companies. Some are tech focused, some are other healthcare focused. And then you've got bond funds. And these are really fixed income. These are for people who don't like the volatility of the market. They just want something stable. So these invest in corporate or government bonds. There's regular interest income, lower volatility. So some people like that.

[B]

This is just getting nerdier and nerdier. I'm liking it.

[A]

It's. Yeah, I'm trying to put it on the bottom shelf so that in five minutes we can all go, great, we learned it. Yeah, we can move on. And then lastly, money market fund. So you hear about that. That's almost like a high yield savings account basically where it's just sort of sitting short term debt instruments. But it's high liquidity, meaning you can take that money out and you're not going to worry that it's going to go up and down. It's just going to sort of sit there making a little bit of interest like a savings account.

[B]

Love that. So George, how do mutual funds make money? I mean you told us what they are, but technically how are they making money? Are we making money every time the company makes money or how does that work?

[A]

Yeah, so as the company stock share value goes up, we make money. And sometimes that's paid out in a dividend. So think of that like profit sharing. The company made some profit. They're going to reward the shareholders for holding onto these stocks for the long term by giving them a little bit of money.

[B]

Love that.

[A]

Or it can be reinvested. And so that's what we do in our retirement accounts. We're not getting dividends off of that. We're just reinvesting the growth.

[B]

That's right.

[A]

And that's what creates this amazing compound growth. And the other way is capital gains. So when you sell it for a higher price, if I buy Apple stock at $100 and five years later it's $150, well, I made 50 bucks per share.

[B]

That's great.

[A]

That's another way to make money. If I sell that. And now you don't want to do that in a retirement account. But unless you're of age to retire, that's true. But if you're, you know, under 60, you want to just hang on. But if it's in a taxable brokerage account, meaning it's non retirement, you would sell and you would have capital gains tax either short term or long term, depending if you've held it for a year or longer.

[B]

So George, I hear Dave and you guys and myself all the time we talk about the four different types. Can you go through those so that people know once and for all we're talking about?

[A]

So you'll hear Dave say growth and income growth, aggressive growth and international. Here's what you might see that listed as. If you're looking at your 401k for example, you might see it listed as large cap. That would be your growth in income. These are large, boring, stable companies like your Home Depots. They're out there. They're not going to be skyrocketing. They're not like innovating in crazy ways, but consistently. Yeah, you need these as the foundation. Then you have the medium cap, which is going to be your growth funds. So these are medium to large companies. Then you have small cap. These would be considered your aggressive growth companies like small tech startups. And those are going to be the wild child. It's going to go really high.

[B]

That's right.

[A]

And then finally international. So you want to have this as a hedge. Think like BMW, lg, Samsung. These are international companies. And what we found, Jade. When the US market just took a dip like it did recently, what happened? International funds.

[B]

So they balance each other out.

[A]

So it balanced out. And people have said, well Dave, international funds have been out, you know, underperforming the US stock market for a long time. Should we switch that up? And we just saw a great example of why Dave keeps international as a quarter. So when you talk about investing in your retirement account, we recommend just a quarter in each 1/4. So 25 in that large cap, 25% medium, 25% small 25% international. And if you just choose those four funds in your 401k that have a long track record and have a solid return, you're going to be okay. It's as simple as that.

[B]

That's right.

[A]

You don't need to overcomplicate it.

[B]

I love that. I feel like you made it very clear for us.

[A]

I tried. And we do have a. There's, there's some great next steps you can take. And number one is connecting with a SmartVestor Pro. So these are financial advisors that can teach you all of this stuff in depth, that you understand what you're doing. They're not making decisions for you. The ball is in your court. But you need to know what's going on with your investment so you can reach out. Connect with a SmartVestor pro ramseysolutions.com SmartVestor or click the link in the description if you're listening on YouTube or podcast.

[B]

Very, very good. I like it. This is very, very helpful stuff. All right, George.

[A]

I'm the Miss Rachel of mutual funds. You know, I try to just keep the cookies on the bottom shelf.

[B]

You said the Ms. Rachel?

[A]

Yeah, that's for kids. Oh, you're beyond that phase. I'm in the Miss Rachel phase right now.

[B]

Oh, so this is like cocoa melon, that kind of deal. Got you.

[A]

Thanks for tuning in to Ramsey. Everyday millionaires need help with your investments? Connect with a SmartVestor Pro at RamseySolutions. Do SmartVestor or click the link in the show notes. Ramsay Solutions is a paid non client promoter of participating pros. Learn [e-mail] SmartVestor.