Investing in the market can be complex due to the numerous products in the market. Of all the mentioned investment schemes, mutual funds are one of the most active investment schemes that are preferred by new as well as experienced investors. They present a means of expanding the portfolio and increase the chances of building up wealth in the long run. This article aims at outlining what mutual funds are, how they operate, and why you should consider putting your money in them.
What Are Mutual Funds?
A mutual fund
on the other hand is a collective investment where the pool of money collected
from various investors is used to purchase the securities that are included in
the fund portfolio. They are invested by professional portfolio managers who
intent to reach certain targets of investment including growth, income or
conservative capital.
Types of Mutual
Funds
1.Equity Funds: The following
are the characteristics of these funds: These funds mainly invest in stocks.
They have capital appreciation as their main objective and they are always
associated with high risks but with high returns.
2.Bond Funds: These are also
known as fixed income funds because they are mostly made up of bonds and other
debt related securities. They are less volatile than equity funds and the
primary objective of these funds is to give regular income.
3.Balanced Funds: These funds
divide the invested amount into stocks and bonds to manage the risk reward
ratio. They are meant to offer capital appreciation as well as the regular
income.
4.Money Market Funds: These invest
in short term, low risk securities such as T bills. They give a lower rate of
return but are deemed to be very secure.
5.Index Funds: These funds
mimic the performance of a certain market index, for instance, Standard &
Poor’s 500. They try to mimic the returns of the index and usually have lower
expense ratios.
6.Sector Funds: These are
tactics that are fine tuned to certain areas of the economy for instance the
technological sector, the health sector or the energy sector. They provide
specific opportunities but with higher risks because they are concentrated.
How Mutual Funds Work
Pooling of
Funds
Mutual funds are investment products in which
you pool your money with other investors. Thus, the pooled money is invested in
a pool of securities with an aim of diversifying the investment portfolio. An
investor has an account in the mutual fund and holds certain shares that are
proportional to the total funds of the mutual fund.
Professional
Management
The management of mutual funds is done by fund
managers who have the responsibility of buying and selling securities depending
on the objective of the particular fund. These managers research, strategize
and buy stocks they think will be profitable in the near future.
Diversification
The first key strength of mutual funds is
based on diversification. In this way, mutual funds help to minimize the risk
of any one security by investing in many different ones. This is useful in
moderating the returns and to avoid big losses.
Net Asset Value
(NAV)
NAV stands for Net Asset Value of a mutual
fund share which gives the value of a single unit of the mutual fund. NAV is
arrived at by dividing the total amount of the fund’s assets by the number of
shares floating in the market. NAV is usually calculated at the close of each
trading business day.
Fees and
Expenses
Mutual funds impose charges on the basis of
management and administration costs. These can include:
Expense
Ratio:
This is the charge made on an annual basis and presented as a percentage of the
average fund size. It comprises management charges, overheads and other general
expenses.
Load
Fees:
Others have a sales charge called a load if you buy or sell shares in the fund.
Front end loads are charged at the time of purchase while back-end loads are
charged at the time of sale of the shares.
No
Load Funds: These funds do not have any sales loads and the expense ratios
could also be relatively lower.
Benefits
of Investing in Mutual Funds
Diversification
Mutual funds give you immediate
diversification, which means that your investment is spread out over a number
of assets and therefore, the risk is lessened. Thus, mutual funds make
investments in a number of securities and prevent the risk of loss of any
single security.
Professional
Management
Mutual funds also provide you with
professional portfolio management which you would not otherwise have. Fund
managers know the strategies, the methods and the tools that help them to make
the right decisions on your behalf as an investor who lacks the time or the
expertise to make such decisions.
Liquidity
Mutual funds are very liquid securities that
are easy to buy and sell due to their nature of being managed by a fund
manager. It is also very flexible in the sense that mutual fund shares can be
purchased and sold on any business day and the investor can easily get at his
or her money whenever he or she needs it. This comes in handy especially when
the investor may be in need of the cash within the shortest time possible.
Affordability
It is also easier to start with mutual funds
than placing a large amount of money in the market. This makes them easier to
approach for investment by virtually any investor, even the one with small
capital. Some of the funds also provide the features of Systematic Investment
Plans (SIPs) where you can invest a certain amount periodically.
Variety
Mutual funds are numerous, in the range of
thousands, and they all have different goals and approaches to investments.
Here you can select the funds that fit your needs notably through your
investment objectives, your tolerance to risk, as well as the time period
within which you are willing to invest in.
Considerations
Before Investing in Mutual Funds
Risk
As for mutual funds, they provide
diversification which is a great advantage; however, they also come with
certain risks. The market price of a mutual fund share will rise or fall
depending on the performance of the underlining securities. It is crucial to
know the particular dangers of the fund type you are looking at.
Fees and
Expenses
It is also important to note that there are
charges and costs that are involved in mutual funds which will in one way or
the other affect the returns. Check the expense ratio and the load fees of the
various mutual funds so that you are getting your money’s worth.
Performance
The only problem with the past performance is
that it is not an indication of the future performance, although it reveals the
quality of the management of the fund. Examine the historical results of a
mutual fund and its standard and rival indexes.
Investment
Objectives
The investment objectives of the mutual fund
should be similar to your own objectives. For instance, if your target is to
have long term returns then equities fund may be ideal. For steady income, go
for a bond fund.
Conclusion
Mutual funds are an attractive way of
investing in a number of securities, receiving professional management of the
funds, and attaining your financial objectives. Thus, one can comprehend the
concept of mutual funds and decide whether to invest in them or not to achieve
their desired goals. If you are a new investor or already have an existing
investment plan, then mutual funds are a great way to diversify your
investment.