Mutual funds are a form of collective investment that pools money from many investors and then invests the money in stocks, bonds, short-term money-market instruments, and/or other securities. Mutual funds are legally known (in the US) as an "open-end company," mutual funds are one of three basic types of investment company available in the US. Outside of the US, mutual funds is just a generic term for various types of collective investment. In the UK and western Europe (including offshore jurisdictions) other forms of collective investment are prevalent including unit trusts, Open-Ended Investment Companies (OEICs), SICAVs and unitized insurance funds.
The portfolio manager trades the mutual funds underlying securities, realizing a gain or loss, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. There are more mutual funds than there are individual stocks. US mutual funds are by definition open-end funds. This means that at the end of every day, the investment management company sponsoring the fund issues new shares to investors and buys back shares from investors wishing to leave the fund.
A relatively new innovation, the exchange traded fund (ETF) combines characteristics of both open and closed end mutual funds. An ETF usually tracks a stock index, like an index fund, but can be redeemed on demand for its underlying holdings, eliminating the discounts and premiums that are common with most closed-end funds and forcing prices to remain very close to the net asset value (NAV). ETFs are traded throughout the day on a stock exchange, just like closed-end funds.