Today’s generation prefers to invest money rather than saving it in accounts. Mutual Funds are the most common financial tool among investors to pool their money for a shorter or longer duration and gaining interest from it. The money invested by the investors is professionally managed by experienced people who can buy or sell a diversified or well-mixed number of stocks, bonds, or money market securities for the fund. As a mutual fund investor, your portfolio is made up of as many as several hundred different securities.
Mutual Funds are designed for every individual investor diversification and money management, even for small investors who invest low amounts. Mutual funds are an appropriate investment option to consider for investors who just began investing, if you don’t have a lot to invest, or if you want diversification in your portfolio.
How Did Mutual Funds work?
1) A mutual fund pools money from its many investors to purchase securities for the fund’s portfolio. The investors typically own a portion of their portfolio which includes many other instruments they can afford to purchase. The value of the investor’s share in that portfolio increases or decreases which is based on the value of the investments in the portfolio.
2) Every mutual fund has a specific investment objective. Most of the investors invest their money in various types of mutual funds like stocks, bonds, etc or a combination of these. Within these fund investments, a Stock mutual fund is emphasizing on domestic or foreign stocks or any other particular industry whereas a bond fund may concentrate on investments for short term or long term maturities, or on government securities.
3) A mutual fund distributes its income and capital gains. Any income received from stock dividends or bond interest to the shareholders along with any capital gains from the sale of securities is distributed, as the fund buys and sells the investments within the portfolio.
All the investments involve risk but the rate of risk and the rate of returns differs. Generally, when the rate of risk increases, the potential return also increases. To become a successful investor, one has to match the mutual fund’s level of risk with his own ability to tolerate risk to match your objectives with that of the fund.
Advantages/ Benefits of Mutual Funds
1) Economies of Scale
If you buy dozen of donuts that will become cheaper than buying a single donut. So similar is the case with buying and selling of securities. Thinking about volume discounts is the easiest way to understand the economies of scale. If you buy single security at a time, the transaction fees will be relatively more.
Sometimes, the investors don’t have the exact amounts of money to buy round lots of different securities. Investors can buy mutual funds in smaller denominations also. Smaller denominations of mutual funds help the mutual fund investors to make periodic investments through monthly purchase plans. So, rather than waiting to have enough money, you can get in right away with mutual funds. This provides an additional advantage – liquidity.
Another advantage of mutual funds is the ability to get in which means purchasing and out which means selling with relative ease. So basically, you can sell your mutual funds in a short period of time without being much difference between the sale price and the current market value. However, one needs to look out for any fees associated with selling, including back-end load fees. Unlike stocks and other types of funds, which are traded at any time during the market hours, mutual funds can transact only once per day only after Net Asset Value is calculated of the fund.
4) Professional Management
It is obvious that when you are buying a mutual fund, you are also choosing a professional money manager. This manager will professionally use the money, which you invested to buy and sell stocks that he or she has carefully researched. Thus we can say that, rather than thoroughly researching every investment before you decide to buy or sell, you have a mutual fund’s money manager to handle it for you.
5) The Bottom Line
All the investments involve risks. So these investments can experience market fluctuations or provide returns below the overall market. The advantages of mutual investments are not free, they also include loads, annual expenses, and penalties for early withdrawal.
Be sure to read the prospectus before investing
The prospectus gives you the information about how the fund will be invested, how you may purchase shares, how the fund will be administered, and what it will cost you as fees and other expenses.