Final answer:
Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of securities. Shareholders receive tax summaries for dividends and capital gains that must be reported on their tax returns.
Step-by-step explanation:
Mutual funds are investment vehicles that allow investors to pool their money and invest in a diversified portfolio of stocks, bonds, or other securities. These funds are managed by professional fund managers who allocate the fund's assets with the goal of generating returns for the investors. When an individual purchases shares in a mutual fund, they become a shareholder and their investment increases or decreases in value based on the performance of the securities within the fund’s portfolio.
Mutual funds offer several advantages, including diversification, which helps reduce risk by spreading investments across a variety of assets. Some mutual funds may concentrate in specific sectors, such as technology or healthcare, while others might offer broad market exposure. For example, index funds aim to track the performance of a market index, providing investors with returns that mirror the overall market's performance.
Regarding taxation, mutual funds do provide tax summaries to shareholders. These summaries report dividends and capital gains distributions, which are typically subject to tax. It is crucial for shareholders to report this information on their tax returns. The increase in popularity of mutual funds is evidenced by reports such as the Investment Company Factbook, which showed that in 2021, over 47% of U.S. households were invested in mutual funds.