The basic idea of a mutual fund is straightforward. Investors pool their money and hire a portfolio manager to invest in a variety of investment securities.
When an investor buys a mutual fund, their investment dollars are used to purchase new shares of the mutual fund. In other words, shares of the mutual fund are created for the new investor, these new shares are issued to the new investor, and the new investor’s dollars are combined with dollars of the other mutual fund holders.
The manager of the fund, called the portfolio manager, then buys investments according to the objective of the fund. The fund’s prospectus will inform investors of the fund’s objectives. The result is that investors can invest a potentially small amount of money, but have access to a professionally managed and diversified portfolio.
See What Is a Mutual Fund? for a detailed look at the definition of a mutual fund.