A mutual fund is a collective investment fund that pools together the funds of a pool investors to purchase securities with an aim of making a return. Securities could include equity(stocks), debt(bonds) or derivatives(call options, futures, commodities.etc).
Mutual funds are very affordable, diversified, liquid and have professional fund managers. On the negative side thay have a lot of fees, uncertain exit prices and little transparency into how the funds are operated.
Advantages of Mutual funds
Affordable: Mutual funds are very cheap to get into as the share prices are very affordable per unit.
Diversified: Mutual funds tend to hold a large portfolio of financial instruments from different industries. This makes them incredible diversified and reduces the risk of a negative net asset value as if one industry does bad it is more probable that another industry which the mutual fund holds in its basket will be doing good if not much better.
Liquid: There is a very liquid market for mutual funds on the stock exchange which makes them easy to get into and easy to exit. You can redeem your shared for their net asset value minus any fees.
Professional fund managers: Fund managers who manage mutual funds are very experienced and qualified.
Disadvantages of Mutual funds
Fees: Regardless of the funds returns you will still have to pay fund fees.
Uncertain exit prices: The prices to redeem and exit your investment depends on the funds net asset value.
Little transparency: You have little say or none over most decisions made and usually you don't know of such decisions. Depending on how you look at it, this could be a good or bad thing.
Mutual funds are traded on the stock exchange. When you purchase a share in a mutual fund you have a stake in a part of the fund relative to your shares. This means whatever returns are made will be paid out to you relative to your ownership of the mutual fund.
Mutual funds can be a good way to make a diversified investment as the hold a variety of financial instruments. Mutual funds make it easier for new investors to get into the market without having to do too much research into each individual financial instrument or stock. New investors can be satisfied that they have a diversified fund which is being watched and managed by a certified, experienced investment manager.
How do you choose the right mutual fund?
To choose the right mutual fund you will want one that matches your investment goals. You can search and compare mutual funds from their ratings and feedback given by other investors and then find one which matches your investment goal.
You should look at the mutual funds past performance although this shouldn't be taken as an indication of future performance.
You should look at the mutual funds prospectus and the types of financial instruments it holds.The mutual funds prospectus is the official document which gives you a full overview of how the mutual fund invests and operates. It should contain information such as:
- The minimum investment amount
- The investment managers
- Any fees and charges for the mutual fund
- The mutual funds performance history
Once you own shares of a mutual fund you will now participate in the gains and losses of all the financial assets which the fund holds. Mutual funds tend to hold a large amount of financial assets and this is especially good as mutual funds are very diversified. This means if a particular industry which the mutual fund holds stock of is doing bad and another is doing good your investment portfolio will remain relatively balanced.(the Funds Net asset value will remain stable)
Types of Mutual funds
Equity mutual funds:
This mutual fund focuses on buying company stocks
Fixed income mutual funds: This mutual fund focuses on buying bonds
Balanced mutual funds:
This mutual fund buys both stock and bonds.
Index mutual funds:
This mutual fund will buy the stocks of a particular index in order to track its price performance. E.g the S & P 500 mutual fund.
Country Mutual funds:
This mutual fund will focus on stocks of a particular country
Market Mutual funds:
This mutual fund will focus on stocks from a particular market e.g the biochemical market or the technology market.
Growth stock Mutual Funds:
This mutual fund marks a different segment of mutual funds which will, focus on unique things such as riskier stocks or new trends. This mutual fund focuses on stocks which are expected to grow in the future and by nature they are more risky stocks.
Value Mutual fund:
This mutual fund will look to buy stocks of established companies with stable growth
Costs of Mutual funds
Mutual funds are actively managed by fund managers. This means the fund managers actively look at the stocks or financial instruments in the fund and reduce or increase their holdings as they see fit.
Mutual fund managers get paid an annual fee which is taken as a percentage of the total assets under management. This is taken every year regardless of the performance of the mutual fund. Due to this feature, mutual funds are known to be more expensive than other financial instruments such as an ETF.
Mutual funds also have other costs such as transaction fees and in some cases a sales load: which is a cost to buy or sell shares. Some mutual funds will also add an additional load charge if shares of the mutual fund are sold within a particular time frame.
How to make money from a mutual fund
Appreciation of mutual funds value
To make a return from a mutual fund you will need the financial assets in the mutual fund to appreciate more than any loss in value from some financial instruments contained in the mutual fund(positive Net asset value). When this happens the mutual funds shares will usually rise in value. Unlike stocks the value of a mutual funds shares does not change throughout the trading day but is instead calculated and updated at the end of the market trading day.
You can then sell your mutual fund for a higher price than you bought in due to the rise in value.
If the financial instruments that the mutual fund holds fall in value more than any increase in value from the financial instruments that it holds then the mutual funds share prices will usually follow and fall in value.
Mutual fund dividend payouts
Another way to make money from mutual funds is through dividend payments. This is when a mutual fund pays out a portion of its earnings to its investors(shareholders).