Mutual Funds – What You Need To Know
A mutual fund is a form of investment that basically diversifies your investment portfolio. This is because unlike investing in a single item like stocks, with a mutual fund you get to pool several assets and obtain returns from different directions. Mutual funds allow investors to put their money in stocks, bonds and cash without having to make any separate purchases or trades. It’s basically the simplest form of investment to build a diversified portfolio.
When mutual funds were introduced, investors were able to participate in the stock market in a manner that was not possible before. We all know that the largest form of investment nowadays is through stocks. But as an investor, you need to look at several options that can make you money and divide the risk. That’s why mutual funds allow you to consider options such as index funds, sector funds and growth funds. All these different kinds of mutual funds are issued by companies to allow their customers to make informed investment decisions.
The price of each share in a mutual fund is determined by NAV which is the net asset value. This is simply the total value of the assets or securities that the fund owns divided by the total number of fund shares outstanding. NAV fluctuates on a daily basis.
Before buying any mutual funds, it’s important to speak to a financial advisor who will explain to you the best form of investments especially if you are looking for a form of investment for your retirement savings. The investment strategy that is best for you will be dependent on your age, date of retirement and other factors which a financial advisor can walk you through.
But like all the other forms of investment, you need to understand that mutual funds have risks too. There are also costs involved with this kind of investing. Operating costs may vary depending on your mutual fund company. Make sure you know the fees prior to signing any agreement. Go through the shareholder fees to understand how much you are expected to pay.
You also need to note that you don’t have to be in a 401(k) in order to invest in mutual funds. This is a form of investment that is suitable for anyone. Just make sure you confirm that the mutual fund you are about to invest in is a proper fit for your portfolio.
Why Invest in Mutual Funds
There are many good reasons to invest in mutual funds. For most people, it’s one of the best investment decisions they have ever made because this is money that is managed professionally and offers diversification. The simplicity of mutual funds means that investors with little financial management background; time or money can still use this as a suitable investment vehicle. So we will look at some good reasons to invest in mutual funds.
- It is professionally managed
A mutual fund allows you to take advantage of an experienced professional who will choose the right forms of investment to ensure the fund grows. Once you put in money in the fund, the manager will decide which stocks to buy and sell in order to make a profit; which means you don’t have to put in all the hard work, time and research involved when making investment decisions.
Getting in and out of a mutual fund is quite easy compared to most forms of investment. You can easily get a suitable buyer for your mutual funds in case you want to sell them but keep in mind that you can only sell them after the NAV is calculated at the end of the day. However, there are certain fees that you will have to pay when selling your mutual funds such as the back-end load fees.
- Suitable for small investors
Mutual funds allow you to make smaller transactions without having to incur numerous commission charges. You are also able to make large-scale transactions for less money when it comes to buying mutual funds. The more securities you buy, the cheaper the investment is going to be because you get to reduce the transaction fees. But if you choose to buy only one security then you are likely to pay large transaction fees.
- Asset diversification
One important reason why diversification is important when investing is that it helps to reduce the impact one security has on your entire portfolio. Diversification is really the best way to manage risks and this is something that mutual funds offer. You are able to buy stocks from different industries and with varying maturities. But in order to gain adequate diversification, you may need to purchase more than one mutual fund. You want to invest in different industries so that your money is spread over a variety of companies. In case prices fall, your portfolio doesn’t suffer.
How to Buy Mutual Funds
There are thousands of mutual funds in the market. Understanding how to buy a mutual fund is one of the best investment decisions you can ever make. It helps you to choose a mutual fund that will have a positive impact on your portfolio. Factors such as the past performance of the mutual fund are certainly important to consider when making this kind of purchase. But it’s also important to have clearly defined goals and objectives before getting into this form of investment. In this article, we’ll give you 3 important considerations when buying a mutual fund.
1. Understand why you are investing In the mutual fund
Like in any other form of investment, if you don’t know why you are investing then your chances of success will be very slim. Knowing why you are investing will help you to choose the right type of mutual fund for your portfolio. Most people will get into this form of investment in order to save for retirement. This means that factors such as your age, health and wealth must be considered when buying mutual funds. But people invest for different reasons so always make sure you consider your unique situation. If you are investing for retirement purposes, understand that life doesn’t stop after you retire. You could still invest because you may have three or more decades in life.
2.What level of risk can you take?
Despite the popularity of certain types of mutual funds, always understand the level of risk that you are able to take when investing. For instance, if you want to buy mutual funds and you have a spouse whose pension covers your living expenses, you can allocate more money to stocks even though it’s somewhat risky. The other dilemma you are likely to come across is whether to invest in index funds or a more actively managed fund. Remember that index funds track a specific index.
3. Consider fund performance
It’s always important to know how the mutual funds you are interested in buying have performed in the past. However, keep in mind that there are certain seasons where almost all mutual funds experienced a sharp decline. Just look at the fund’s absolute return and compare this with funds offered by different companies. Just because a fund has been performing extremely well for three years in a row doesn’t mean that they will keep up the same level of performance. You need to know the strategy they play to understand what is expected from the fund in the future.
The Risks Involved
Mutual funds also pose some level of risk. The kind of risk involved will depend on what the fund invests in. In many cases, if the chances of obtaining great returns are high then the risk will be higher. We will look at different types of risks of mutual funds and try to explain how you could end up losing money if that risk is not mitigated.
Currency risk: If you invest in a particular currency then there is always the risk of it declining and you end up losing your money. Your investment can easily lose value if the currency in which you chose to invest in has declined.
Credit risk: This is mainly a risk observed when buying fixed income securities. Trouble comes in when the bond issuer is unable to repay the bond. This can happen because they went bankrupt and are unable to meet their financial obligations. You will end up losing your investment.
Liquidity risk: All types of mutual funds are exposed to this type of risk. There may come a time when the fund cannot find a suitable buyer for an investment that is declining in value. No one wants to buy a worthless investment and hence you may end up selling it at a loss because there are no buyers.
Interest rate risk: This is also a type of risk that is more common in fixed income securities. The value of your investment is likely to go down when there is a significant rise in interest rates. This means there’s a risk of losing your money.
Foreign investment risk: When you invest in foreign countries then there is always the risk of losing your money because of issues such as political instability in the country where the investments were issued. You need to assess the level of risk a foreign investment presents and understand the challenges the country is facing and how this is likely to impact on your own mutual fund.
Market risk: This is another form of risk that will be there regardless of the type of mutual fund you choose to invest in. There are certain things that are unavoidable and will affect the entire market. When this happens, the value of your investment will decline.
Before buying a mutual fund, understand the level of risk involved and what the company that is issuing it has done to reduce this risk.
The Different Types of Mutual Funds Available
The kind of securities you invest in a mutual fund will depend on your goals. The different types of mutual funds allow investors to choose a program that is designed to suit the level of risk they are willing to make and at the same time fulfill their goals. We’ll look at a number of mutual fund schemes to help you obtain basic information prior to making any decisions.
Open-ended mutual fund programs: This is a mutual fund scheme that allows an investor to buy or sell securities whenever they want. There’s really no fixed maturity date which helps to minimize the risk involved in a mutual fund.
Index schemes: When you invest in an index fund then it means that your security will perform based on the movements of certain index’s. Popular index’s such as Nifty and Sensex act as a benchmark that determines how well your investments perform.
Sector funds: If you would like to invest in a specific sector such as construction, you can buy sector funds. Sector funds simply focus on a particular segment of the economy. This is a program that allows investors to obtain high returns, but they really have to take some high level of risk.
Close-ended mutual funds: When you invest in a scheme that has a specific maturity date then you have bought a close ended fund. Investors can only buy during the initial launch.
Fixed maturity plans: FMPs are a form of close ended mutual funds because there is a defined maturity period. The good thing with fixed maturity plans is that they have lower expenses or fees charged to manage them mainly because there is no active trading of debt instruments in the portfolio.
Inverse funds: These are usually sought after by sophisticated investors who are looking to take high risks in order to generate some good returns. These funds increase in terms of value when the market is not performing well and decrease as the market rises. Unlike traditional mutual funds, they don’t perform well in downward moving markets so investors use them to profit during such seasons.
Bond funds: This involves investing in numerous individual bonds from different sectors. For instance, you can choose a fund that only invests in treasury bonds whereas another invests in corporate bonds. You can choose to invest in short or long term bonds depending on your goals and the amount you would like to invest.
Mutual Funds V Hedge Funds
There are certain similarities that exist between mutual funds and hedge funds. For starters, both of them are managed portfolios. This means that as an investor, you can make some good money with or without any financial knowledge or having to research on what’s going on in the market. There is a manager or a group of manager to do all the work for you. They simply use their expertise to choose the securities that will bring you the most value. Both are also a great way to instantly diversify your portfolio and have your money managed professionally. But here are the differences between mutual funds and hedge funds.
For a start, hedge funds aim at producing positive returns regardless of how the market is doing. This is not the same as mutual funds because in most cases they will not perform well if the market is declining. Mutual funds are usually managed relative to an index benchmark. This means that when an index is performing low then the mutual funds will not give positive returns. On the other hand, hedge funds aim to offer absolute returns.
Secondly, with a hedge fund, the manager is also expected to put in a certain amount of the capital required in order to gain trust from the investor. If this expectation is not fulfilled then this can be interpreted as a bad sign. But when it comes to mutual funds, the manager is not expected to risk his own money in the strategy.
Thirdly, mutual funds are considered more liquid compared to hedge funds. You may be able to withdraw your mutual funds at any time, unlike hedge funds which usually have a lockup provision that only allows you to withdraw the funds at specific periods.
The other major difference between these two popular forms of investing is that mutual funds are offered via a prospectus, unlike hedge funds which are issued through a private placement memorandum. This means that the paperwork involved will be very different when buying any of the two funds.
Lastly, mutual funds do not present as much flexibility as hedge funds. This is because the manager of a mutual fund cannot easily change his strategy. But when it comes to hedge funds, there’s that freedom to change the strategy quickly because there are only a few constraints to deal with. Consider all these differences when choosing a type of fund to invest in.