A mutual fund is an investment company that qualifies for special treatment under the tax law. That special treatment permits mutual funds to pay dividends that may include long-term capital gain or tax-exempt interest. To qualify for special tax treatment, mutual funds must comply with rules concerning the types of investments they make, the payment of dividends, and various other matters.

How to Invest
If you think a mutual fund is the thing for you, the first step is to get an idea what type of mutual fund you're interested in. Stocks? Bonds? Some of both? Do you want a managed fund or an index fund? Are you more interested in growth stocks or income stocks? Do you want some or all of your money to be invested overseas?

When you have an idea what type of fund you want, research the mutual funds in that category. There are many sources of information on mutual funds on-line and in your library.

When you know what you want, you need to either contact the fund itself or establish an account with a broker that provides access to that fund. Check in advance with your broker, because not all funds are available through all brokers. From this point the process should be easy, involving filling out some simple forms and writing a check.

You Are a Shareholder
Mutual funds are often explained as a way for small investors to pool their money together for investment purposes. You may be able to make deposits to and withdrawals from your mutual fund account in much the same way as you do with your bank account. So many investors start to think of their mutual fund account as sort of a glorified bank account, and lose sight of the following:

When you make a deposit to a mutual fund account you're buying stock in the mutual fund.

You may feel that you're an owner of whatever the mutual fund holds. In a loose sense that's true, but it's not really accurate. In reality you own shares of stock in a company (namely the mutual fund), and that company owns the investments. That changes the way you report the income.

You don't have to report anything on your tax return when you take money out of a bank account. (Any interest you receive is taxed when the interest goes into the account.) But when you take money out of a mutual fund account, it's a sale of stock. That means you have to report a sale on your tax return, usually reflecting a capital gain or loss. So there's a little more thought that should go into a withdrawal from a mutual fund account.