Final answer:
When the investments owned by a mutual fund change in value, the value of your investment in the fund also changes. If the investments increase in value, your investment increases, and if they decrease, your investment decreases. This is due to the direct link between the performance of the fund's holdings and your investment value.
Step-by-step explanation:
If the value of the investments owned by the mutual fund goes up or down, what happens to your money? The correct answer is d) It depends on other external factors. However, in most cases, the value of your investment changes directly with the performance of the mutual fund’s holdings. When the fund's investments increase in value, the value of your investment, or the money you have in the mutual fund, typically increases. Conversely, if the value of the fund's investments goes down, the value of your investment is likely to decrease. This fluctuation is a direct result of the market valuation of the underlying securities that the mutual fund holds.
As an investor in a mutual fund, you are effectively pooling your money with other investors. The fund manager uses this pool of funds to diversify by investing in a range of companies, stocks, and bonds. Diversification is the strategy of spreading investments across various sectors to reduce risk. A mutual fund that aims to mirror the broader market is known as an index fund. The principle behind this is that by investing in a broader market index, the fund avoids the risks associated with individual stocks.
The bottom line is that while the potential rate of return over time can be high with mutual funds, so can the risks. The risks and returns for an individual mutual fund will be lower than those for an individual stock due to diversification. Liquidity, the ease with which an asset can be converted into cash without affecting its market price, is also high for mutual funds, especially if the fund is readily traded.