What are Mutual Funds?

A mutual fund is an investment vehicle that brings together money from multiple investors to create a diverse portfolio of securities, such as stocks, bonds, and short-term debt. These combined holdings are referred to as the mutual fund's portfolio. Investors can participate by purchasing shares in the fund, with each share representing a proportional ownership stake and a share in the income generated by the fund's investments.

Why do people buy mutual funds?

Mutual funds are a preferred investment option among investors, offering several key benefits such as:

1. Professional Management: The fund managers research and select the securities, while also monitoring their performance, which eliminates the need for investors to do it themselves.
2. Diversification: Mutual funds usually invest in a variety of companies and industries which helps to minimize risk should one company fail.
3. Accessibility: Mutual funds generally have low initial investment and purchase requirements, making them accessible for a wide range of investors.
4. Liquidity: Shareholders can easily redeem their shares for the current net asset value, with any redemption fees added on top.

What types of mutual funds are there?

Mutual funds can typically be grouped into four main categories: money market funds, bond funds, stock funds, and target date funds. Each of these types of funds have their own unique characteristics, risks, and potential rewards.

Money market funds are considered relatively low-risk investments as they can only invest in high-quality short-term debt instruments issued by U.S. corporations and government entities.

On the other hand, bond funds tend to carry higher risks than money market funds as they aim to generate higher returns. The risk and returns of bond funds can vary widely depending on the type of bonds they invest in.

Stock funds, which invest in corporate stocks, come in various forms. Growth funds aim to capitalize on the potential for above-average financial gains from stocks that may not pay regular dividends. Income funds, on the other hand, focus on stocks that pay regular dividends. Index funds track a specific market index, such as the S&P 500, and sector funds target a specific industry segment.

Target date funds, also known as lifecycle funds, hold a combination of stocks, bonds and other types of investments. The allocation of assets in these funds changes gradually over time to align with the fund's investment strategy. These funds are designed for investors with specific retirement goals in mind.

What are the benefits and risks of mutual funds?

With mutual funds, investors have the benefit of professional management and the possibility of diversification. These investment vehicles also provide three ways to earn returns:

1. Dividend payments: Mutual funds may earn income from dividends on stocks or interest on bonds, and distribute a portion of this income to shareholders, after deducting expenses.
2. Capital gains distributions: If the price of the securities held in a fund increases and the fund sells them, the fund may realize a capital gain. These gains are distributed to investors at the end of the year, after accounting for any capital losses.
3. Increase in net asset value (NAV): When the market value of a fund's portfolio increases, after deducting expenses, the value of the fund and its shares will also increase. This results in a higher NAV, reflecting the increased value of the investor's investment.

When investing in mutual funds, it's important to understand that all funds come with a certain level of risk. The value of the securities held in a fund can decrease, resulting in a loss of the money invested. Additionally, dividends or interest payments may fluctuate based on changing market conditions.

It is important to note that a mutual funds past performance is not necessarily indicative of future performance. However, past performance can give an idea of how much the fund's returns have varied over a certain period, volatility is associated with higher risk.

How to buy and sell mutual funds

When investing in mutual funds, investors purchase shares directly from the fund or through a broker, instead of from other investors. The cost of the shares is determined by the fund's per-share net asset value, along with any additional fees that may be incurred at the time of purchase, such as sales charges.

With mutual funds, shares are redeemable, meaning investors can choose to sell them back to the fund at any point. Funds are obligated to process the payment to the investor within a week.

It's important for investors to read the prospectus carefully before investing in a mutual fund. The prospectus includes important information about the fund's goals, risks, past performance, and expenses that investors should consider before making a purchase.

Mutual funds fees

Like any other business, running a mutual fund comes with costs that are passed along to investors in the form of fees and expenses. These costs can vary between different funds, so it's important for investors to consider them when comparing different options. A fund with high expenses will have to generate better returns than a low-cost fund to achieve the same returns for the investors.