A mutual fund refers to a portfolio of investments under organized management, with a pool of money from many investors used to invest in securities such as bonds and stocks. A portfolio is the combined holdings of the mutual fund. A mutual fund portfolio is geared towards and maintained to matching the investment objectives as stipulated in the prospectus.
In-depth knowledge on mutual funds
Mutual funds are operated by professional managers whose main task is to allocate the net funds collected from the various investors with the aim of capitalizing on gains and income in the interest of the fund’s investors. The value of the mutual funds is dependent on how the securities bought perform in the market.
The money obtained from each investor represents shares of the mutual funds. Therefore, investors by buying units or shares from the mutual funds, are actually buying the portfolio’s performance or in precise terms, a portion of the portfolio’s value. The price of a mutual fund is the ratio of the total value of the securities in the portfolio to the total amount of outstanding shares. This gives the price which can also be termed as the Net Asset Value Per Share (NAVPS).
Most mutual funds hold hundreds of securities. Therefore the shareholders achieve the advantage of diversification which comes in handy at a low price. For instance, an investor who buys stock only from Microsoft just before the firm experiences a bad quarter. This investor is bound to be at a great loss since money is tied to a single security. In contrast to this, an investor who buys shares from a mutual fund that owns some Microsoft stock is at an advantage. When Microsoft experiences a bad quarter, this investor only suffers a small loss since Microsoft is only a small portion of the fund’s portfolio. In fact, the investor in a mutual fund may end up on the gaining side despite the loss from Microsoft.
Earning from Mutual Funds -how they work.
Mutual funds exhibit a dual nature, that is, it is both a company and an invest. As strange as it seems, it beats logic. Investing your money in a mutual fund is an indirect way of buying many different securities, only that the mutual fund does all the work. It behaves like a company in the sense that it is no different than buying shares from Microsoft Corporation. By buying a Microsoft stock, an investor will be buying partial ownership of this particular company and its assets. A mutual fund investor is also in a similar manner, buying partial ownership of the mutual fund and its assets.
A mutual fund investor make earnings or get returns in a number of different ways.
- Dividend payments; these are dividends on the stocks or interest on bonds that are held in fund’s portfolio. The income earned over the year is distributed to the fund investors per share amount. The distributed funds come with the option of the owner receiving or reinvesting the dividend payment for more shares.
- Capital gains distributors; the securities held by the fund may increase in price and subsequently sold by the fund. These gains are distributed to the investors at end of year.
- Increased NAV; if the market value of the fund holdings increases, the value of each share increases thus increasing the investment of the shareholders.
Understanding Mutual Fund Fees
As with every other company or holding, mutual funds incur expenses. These expenses are covered by investors by charging fees. These expenses can be classified into annual operating fees or shareholder fees. Annual operating fees refer to a percentage of the funds charged annually, ranging around 2% in most cases. Shareholder fees on the other hand are paid by investors directly during fund transaction, either purchasing or selling.
The benefits and risks
There are great advantages that come with opting for mutual funds. These include;
- diversification
- easy access
- economies of scale
- affordability
- professional management
Looking at the other side of the coin are the disadvantages of mutual funds. These may include the following;
- fluctuating returns
- cash drag
- high costs
- taxes
Types of Mutual Funds
- Stock funds; This category, also referred to as equity funds, is the most common. It primarily invests in stock (corporate). Further, funds under this category are classified in terms of style of investing, into value fund and growth fund. A value based stock fund looks to invest in high quality but low growth corporations. A growth based stock fund looks to invest in companies that have or are expected to have a strong growth in terms of earnings, cash flows and sales. A third category arises, where a fund stacks in between value and growth investment, and is named “blend” type of stock fund.
- Fixed-income funds; This type of mutual fund is set on investments that earn a set rate of returns. For instance, corporate bonds and government bonds offers such type of security.
- Index funds; This Mutual fund is set on the notion that beating the market on a consistent basis is hard and expensive. The manager therefore buys stocks that correspond to a major market index. An upper side to this is that cost is reduced since less analysts are required.
- Money market funds; Investment is made in extremely safe assets. The money market is characterized by an almost definite risk-free, short-term debt instruments such as government treasury bills. The returns are comparatively low, but one has not to worry over losing their principal.
- International funds; The policy of such funds is that of investing only in assets that are out of country.
- Socially-responsible funds; These are the type of funds which invest in companies that are deemed to be socially acceptable, meeting certain criteria of certain beliefs. Maintaining a healthy conscience is a priority besides attaining a competitive performance. Such criteria may include; green technology, weapons, among others.