Hedge funds don't come up with everyday conversation. And when they do, well, we typically associate them with high-rolling investment characters in movies or TV, like Leonardo DiCaprio grinning wolfishly from a yacht.
But what’s on the screen isn’t always an accurate representation of reality. Hedge funds may not be just "for other people." If you're looking for ahedge fund definition to help you separate fact from fiction, this article is for you. We'll cover hedge funds vs mutual funds to help you level up your financial knowledge and develop an investment strategy that’s right for you.
What are investment funds?
An investment fund is a general term for a pool of money shared by several people. These people contribute their money, or “invest,” their funds so that they can purchase a broader selection of securities while still owning and controlling their own shares. A “security” is just another word for a financial investment, which includes things like stocks, bonds, or ownership options.
There are many types of investment funds. Some common examples include:
Hedge funds
Mutual funds
Exchange-traded funds (ETFs)
Money market funds
Index funds
At the end of the day, the main goal of an investment fund is to make a profit. If you put $1,000 in a mutual fund, you’re doing so in the hopes that you can withdraw more than $1,000 in the future.
Sounds great, right? While it’s a pretty simple concept overall, you'll need to understand the differences between different types of funds before making any rushed financial decisions.
What are mutual funds?
Mutual funds are a type of investment fund that opens the world of investing to individuals who want to increase the variety of their investments and have their portfolios professionally managed. Each investor buys a share in the mutual fund, which represents their slice of ownership in the pool.
Mutual funds offer investors benefits like:
Lowering your risk through diversification. One of the best ways to reduce risk when investing is to diversify your portfolio. In other words, spread your money across different investments so that you’re not betting everything on the success of a single stock or other security.
Providing professional management. Investment funds are managed by expert fund managers who are trained to make informed decisions.
Increasing accessibility. Investment funds reduce the barriers to investing in securities that might otherwise be only available to institutional investors.
Reducing the cost of investment. Since investment funds are made up of pooled resources, individual investors don’t need to meet minimum funding requirements on their own.
While there are plenty of potential advantages to investing in mutual funds, you should also be aware of the possible drawbacks, such as:
Fees and expenses: Since mutual funds are professionally managed, they come with fees, commissions, and other expenses.
No FDIC coverage: Unlike your bank deposits, money that you invest in a mutual fund isn’tinsured by the federal government.
Lack of transparency: While they’re considered more transparent than hedge funds, most mutual funds only disclose their holdings twice a year.
Key differences between hedge funds vs mutual funds
Hedge funds and mutual funds are both types of investment funds, but they’re managed quite differently. In a nutshell, here are the primary differences:
Hedge funds target high-risk, highest-return investments and are only available to certain types of investors.
Mutual funds target lower-risk investments that offer more stable returns and are accessible to retail investors.
But this is just a general overview. Let’s take a closer look at the key differences between hedge funds and mutual funds in each of the categories below.
Investment strategies and objectives
The goal of hedge funds is to maximize profits and increasedividends. So, they take on higher levels of risk and are more flexible in trying out various aggressive investment strategies. They invest in more liquid assets that can be converted to cash quickly, like stocks, currency, real estate, and derivatives.
On the other hand, mutual funds aim to generate long-term growth and positive returns. To achieve this, mutual funds are more conservative in their investment strategies and frequently invest in diversified portfolios to spread out the risk. This includes buying stocks, bonds, and other less liquid securities.
Regulatory oversight and transparency
Hedge funds are less transparent than mutual fund investments because they’re not as strictly regulated. For example, mutual funds must disclose their investment holdings regularly, while hedge funds have fewer disclosure requirements.
As a result, it can be harder to tell how a hedge fund manager is allocating funds. If you want to stay current on a fund’s strategies and portfolio distribution, investing in a mutual fund is a more transparent option.
Accessibility and investor qualifications
You can only invest in a hedge fund if you’re anaccredited investor. That means you either have a liquid net worth of over $1 million, earn more than $200,000 per year, or are a licensed investment professional.
If you don’t fall into one of these categories, then you can invest in a mutual fund. These are open to any retail investor and offer an accessible way to build an investment portfolio.
Another consideration is the minimum investment amount. Hedge funds may ask for an initial investment ofbetween $100,000 and $1 million. In contrast, you can often invest in a mutual fund with just a few hundred dollars. Some mutual funds don’t even have minimum requirements.
Fee structures and performance incentives
Both types of investment funds charge management fees to cover the expenses of managing the fund. Hedge funds typically charge higher fees than mutual funds due to the more active management approach.
Hedge funds often chargeperformance fees as well, which can vary depending on the fund's performance. Many performance fees are around 20% of the fund's profits. While some mutual funds do charge performance fees, the amount is usually lower compared to a market benchmark figure.
Choose the right fund for your investment goals
Even if you can't invest in hedge funds just yet, other investment opportunities like mutual funds may be an option. By learning how to invest in lower-risk funds safely, you can build up the skills and strategies that you need to build your portfolio and succeed in financial markets.
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