A mutual fund is simply a financial medium that allows a group of investors to pool their money together with a predetermined investment objective. The pooled capital is managed by a fund manager who is usually a professional person or firm whose expertise is in stock and bond markets. By pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading cost. Since the fund manager is responsible to invest the pooled capital into specific securities, investors do not need to be well-versed in stocks and bonds because the fund manager will take care of the investments. When you are buying shares of mutual fund, you will become one of the fund’s shareholders. All the gains and losses will be shared among the fund’s shareholders which makes mutual fund a risk-sharing investment portfolio. It provides you a medium of investing your money into a high earning stock & bond market while automatically diversify your investment to reduce your risk. As such, mutual fund can be your alternative investment portfolio that will give you higher reward and lower risk.
How does a Mutual Fund work?
Mutual funds basically take your money, combine it with the money of other investors like you and then invest the total pool of money in investments with the best possible return. The returns from the fund are then split to the proportionate amount of shares owned by the fund’s shareholders. The fund managers then take their cut based on the fees that they charge you and you get your return.
The fund’s Net Asset Value (NAV) is the key concept to understanding how a mutual fund operates. The NAV represents the value of each share or unit of the mutual fund. By this value, you can determine the value of a share of the fund at any time. The market value of the fund’s total assets less any liabilities, divided by the number of shares outstanding, is the formula to understand Net Asset Value. If you work through that, it will show you exactly how much each share in the fund is worth when you are looking to invest in them. By comparing this number over time, you can see the returns earned in a percentage. All these are generally done for you and reported by your fund manager. You can also get information on a funds website or on any of the mutual fund sites that feature mutual fund statistics. You can also get the details regarding the funds’ policies, objectives, charges and services from fund’s prospectus. Every individual or business investor should go through the prospectus before investing in a mutual fund.
Investment Portfolio of Mutual Fund
Mutual funds invest in bonds, stocks, money-market instruments, real estate, commodities or other investments, or many times a combination of any of these. The investment decisions for the pool capital are made by a fund manager (or managers). The fund manager decides what securities and how many quantities are to be bought. Different funds have different risk–reward profile. A mutual fund that invests in stocks is a greater risk investment than a mutual fund that invests in government bonds. The value of stocks can go down resulting to losses for the investors; but money invested in bonds are safe (unless the government defaults – which is rare case.) However, the greater risk in stocks also presents an opportunity for higher returns. Stocks can go up to any limit, but returns from government bonds are limited to the interest rate offered by the government.
Diversification will Lower the Risk
The biggest advantage of mutual funds as compared to direct investments on stocks or bonds is “diversification”. Investment experts always advise that if you want to invest your money, “Don’t put all your eggs into the same basket; else if the basket fall, all your eggs will break”. The same will happen with your money if you invest in one stock. If the stock performs negative, you will lose your investment. When you diversify your investment, you spread out your money into many different types of investments. When one investment is down, another might perform in up trend. Through mutual fund, you can automatically diversify your investment across different kinds of stocks and bonds. Hence, with the diversification of your investment in the mutual fund, you will reduce your risk tremendously.
How much do they cost?
Different mutual funds have different types of fees involved with them as well. Some will charge you an upfront percentage of your investment or front load. Some will charge you a percentage of the investment when sold, this is a back-end load. Then there are no-load funds which charge you nothing more than the annual operating fees. An investor should seek to only use the no-load funds since it saves a lot of your money. There are really no advantages to using a loaded fund unless it offers some incredible returns. But normally, you can find the same rate of returns being offered by different fund companies.
Therefore, it is still best to keep an eye on your personal or business investment at all times. Nevertheless, there are excellent companies and fund managers out there that will successfully manage your investments to your specific needs, no matter how large or small they will be. It is wise to take the time to find just the right company or fund manager.
So hunt around, compare not only price but also service and past record to date. And remember – a mutual fund is still based on the fluctuation of the investment securities that can reduce in value as well as increase – so never invest more than you can afford to be without, just in case!