Mutual fund: What it is, how it works and how to invest
A mutual fund is an SEC-registered investment company that pools assets from multiple investors, known as shareholders, where professional money managers deploy the collected capital across a spectrum of investments with an eye toward generating future investment returns (which, of course, are not guaranteed). While mutual funds predominantly invest in traditional securities like public equities and fixed-income instruments, they may also invest up to 15% of their money in illiquid assets, which may include private companies 1.
What is a mutual fund investment in private companies?
A mutual fund investment in private companies is simply when a mutual fund deploys a portion of its capital to private companies, I.e. companies before they go public through an initial public offering (IPO).
How to invest in a mutual fund?
Through a Financial Advisor or Broker
An investor may gain access to mutual funds through financial advisors—professionals who provide clients with investment expertise, or through brokerages—firms that act as intermediaries between investors and securities exchanges. One potential advantage of investing in mutual funds through financial advisors and brokers is the broad universe of mutual fund choices these investors may be able to access through these service providers. However, this can be an expensive approach to accessing this asset class.
Financial advisors often receive fees, which are fixed percentages of their clients' mutual fund investments. They also collect money from front- or back-end loads, which are fees funds charge investors when shares are bought or sold.
The costs of investing in mutual funds through brokerages can also add up, because such accounts may charge transaction fees for each trade (though this is increasingly less common) --in addition to potentially other fees.
Directly with the mutual fund company
Investors may invest directly with a mutual fund company, whether it's a large investment house or a boutique shop. But the application methodology depends on an investor’s preference. Traditionalists seeking human contact can fill out an application at the purveyor’s nearest brick-and-mortar branch office, as long as they remember to bring essential documents such as proof of identity, a recent photograph, and a voided bank check. Contrarily, tech-savvy investors can directly invest with a mutual fund company online via their laptop, tablet, or smartphone.
Through a retirement fund
Investors may access exposure to mutual funds by participating in employer-sponsored retirement plans like 401(k)s or 403(b)s. In fact, the vast majority of such plans allocate more money to mutual funds than to individual stocks and bonds.
Alternatively, individuals may seek to build their nest eggs by accessing mutual funds through tax-advantaged individual retirement accounts (IRAs). These vehicles may be useful for self-employed people who do not have access to employer-sponsored retirement programs. But – as with any investment choice – there are tax and early withdrawal implications, among other things, to consider before investing through an IRA.
Those interested in opening an IRA may do so through Forge Trust, using its online wizard, DocuSign, or application download functions.
Do mutual funds have investment minimums?
This would vary depending on the specific fund. While some funds have $0 minimum requirements, others require minimums that could range widely (I.e., one fund could have a $500 minimum while another could have a $5,000 minimum). Investors should check with each vendor individually before each trade, because the policies may suddenly change at any given fund house.
Mutual funds, including those that invest in private companies, pool money from groups of investors and use that capital to invest in businesses. Those that do choose to invest in private companies are using some of that capital to invest in companies before the companies go public. Forge unlocks insights into thousands of startups to help mutual fund companies and institutional investors better understand the market for private companies.
Mutual funds investment FAQs
Mutual funds may invest in startups, provided they do not allocate more than 15% of their overall asset allocation to illiquid investments, including private companies. This is because mutual fund portfolios must contain enough publicly-traded companies to maintain the liquidity they need to allow investors liquidity (the ability to sell) expeditiously.
Yes, mutual funds do invest in venture capital, however, it’s sometimes more difficult to obtain reliable valuations in venture capital companies than publicly-traded corporations because there is usually more subjectivity and fewer financial metrics to draw from with the former.2
Yes, mutual funds can invest in private equity, and such activity has climbed over recent decades. In early 2007, only about $110 million of mutual fund assets were invested in private equity. By 2022, that number had swelled to $15 billion. 3
Yes. Because mutual funds are publicly traded on exchanges, their shares may be easily bought and sold throughout the day, like individual stocks.
Private equity investing ties up an investor's money for longer time periods, while shares in a mutual fund may be bought and sold multiple times throughout the trading day. Private equity capital is sometimes deployed to finance a small number of companies, whereas mutual funds may invest in several hundred companies.
About the Author
Andrew Bloomenthal is an experienced financial journalist covering all areas of finance and investment. He previously held positions at Institutional Investor Magazine, Investopedia and CNN. Read more from Andrew.