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A mutual fund is a company that combines, or pools, investors' money and, generally, purchases stocks or bonds. Ideally, a fund's size and resultant efficiency, combined with experienced management, provide advantages for investors that include diversification, expert stock and bond selection, low costs, and convenience.

In terms of legal structure, a mutual fund is a corporation that receives preferential tax treatment under the U.S. Internal Revenue Code. The assets of a mutual fund consist almost entirely of the securities it holds in its portfolio. The most common type of mutual fund, called an open-end fund, allows investors to buy and sell stock in it on an ongoing basis.

How it Works. The mutual fund issues shares of stock (just like any other corporation) to investors in exchange for cash. It is interesting to note that funds do not issue a pre-determined amount of stock, as do most corporations; new shares are issued as each new investment is made. Investors thus become part-owners of the fund itself, and thereby the assets of the fund. The fund, in turn, uses investors' cash to purchase securities, such as stocks and bonds. As mentioned above, the primary assets of a fund are the securities it invests in (other assets, such as equipment, are a relatively small part of the total assets of a fund).