Mutual funds are your ticket to the world of investing.

They provide an easy and cost-effective way to buy a whole basket of stocks or bonds that was put together by professionals.

Here’s how they work: A mutual fund is a large pool of money collected from everyday investors. The people who manage the fund invest the money in a diversified portfolio of stocks, bonds, or other securities – or some combination of them all. Usually their investments are focused on a certain area of the market, like an index, or international stocks or long-term bonds.

As a mutual-fund owner (also known as a shareholder), you don’t own the securities in the fund directly. Instead, you own a slice of the fund, which is divvied up into shares. As the value of the investments inside rise or fall, so does the value of your stake in the fund.

The price at which you can buy or sell shares of a mutual fund depends of the fund’s net asset value (NAV). It’s calculated by taking the current value of the fund’s net assets (the value of all securities inside minus liabilities) divided by the total number of shares outstanding. The NAV is calculated at the end of each trading day.

There are thousands of funds out there and dozens of strategies. Let’s break some of the biggest down by category:

Index funds – are mutual funds that invests in a portfolio of securities that represents a particular market (like the entire stock market), or, a particular piece of a market (say, like, international stocks or small companies). These funds are built to replicate the performance of their relevant market - and so they should track that market’s indexes. For example an S&P 500 index fund aims to provide the exact same return as the S&P 500 index. We’re big fans of these low-cost, low-maintenance funds.

Actively-managed funds – are actively-managed by humans. The humans, also known as portfolio managers, research the vast investment universe and then pick and purchase things that match their investment strategies. Usually, they’re trying to outperform certain indexes. For example, instead of trying to track the S&P 500 index, an active US stock fund manager tries to beat it.

Investors pay these managers for their work. Then they cross their fingers and hope that the manager gets it right and beats the index. Often, however, the managers don’t. It’s hard to beat an index over many years.

Lifecycle funds / Target date funds – invest in a combination of stock and bond funds. Essentially, these funds are mutual funds that are made up of investments in other mutual funds. The fund’s allocation to its underlying investments change over time as you near retirement.

The ratio of money allocated to stocks versus bonds gradually becomes more conservative as the investor grows older. So, for example, a 2040 retirement fund (named for the date that the investor hopes to retire) might be 85% stocks and 15% bonds now but 50% bonds/cash and 50% stocks in 2040.

These work well when you’d rather not pick and choose what to buy on your own, but instead have somebody else manage it for you. You only need to figure out what in which year you plan to retire – and pick the fund that most closely matches that date.

Some target-date funds, like Vanguard's, invest only in index funds, while other providers, like Fidelity or T. Rowe Price, invest in actively-managed funds.

Lifestyle fund – invest in a mix of stock funds and bonds funds that doesn’t change over time. They usually come in a few flavors signifying an investor’s tolerance for risk: conservative, moderate or aggressive. Some lifestyle funds slap on an extra fee on top of the expenses of the underlying funds; these are funds that you should probably avoid.

Balanced fund – invest in a mix of stocks and bonds. These funds typically have a somewhat conservative mix of about 60% in stocks and 40% in bonds.

Tax-managed fund – attempt to keep taxable capital gains and other distributions to fund holders to a minimum. That’s why they’re often recommended for investors who buy them via normal, taxable brokerage accounts (and not via IRA’s or 401ks).

Want to Know More?

• How to Choose a Mutual Fund
• How to Invest in a Mutual Fund
• Grilling Guide: Questions to Ask When Choosing a Mutual Fund