Are you looking for ways to enhance your income? Or are you interested in creating a robust wealth base over a long period of time? If all these answers are yes, then mutual funds can be your right choice. However, you need to choose the scheme that would match all your needs including financial goal, risk profile and investment horizon. Now, before taking an insight into what you can do, let’s take a look into what mutual fund actually is.
Mutual Fund – What is it and the basics you need to know about it
Mutual Fund is a company which do not do anything in particular itself but is operated and managed by investment funds. Investors invest money in this pool to purchase securities. The portion of the holdings are the done my investors who owns shares of the mutual fund. The company of the mutual fund often hires a manager, namely portfolio manager, who is entitled an amount of 0.5 to 2% of the entire assets. The job of the portfolio manager is to invest the money collected by the fund and lay down the strategy in a document called the mutual fund prospectus.
Not all mutual fund offers money to invest. Some of the companies specialize in providing investment options in stocks, gold, bonds or real estate. This list keeps on changing and you can choose one that best suits you. Moreover, the mutual fund organise for a numerous type of niche that gives it the versatility it needs. Some of the funds even provide you the opportunity to invest in dividend stocks which can enhance the dividend every year.
However, investing in mutual fund differs from that of investing in shares of stock. Investment in stock gives the investors voting right which is not applicable for mutual fund shares. In mutual fund investment, a share represents investments in different stocks instead of a single holding.
The types of mutual funds that exists in the economy are –
- Money Market Funds
Money market fund is considerable a safer ground to invest money. This is because it is risk free money market that has short term debt instruments mainly government operated treasury bills. Though there’s less possibility of garnering substantial income, yet you do not have o worry about getting back the principal amount.
- Income funds
Investing in income funds can give you an income on a steady basis, as the name suggests. There is a high probability of profit here as the investments are made in high profile sectors and government. They hold the bill until maturity which helps to generate a steady cash flow.
- Bond funds
Bond fund works by investing in various types of bonds. It actively looks for other bonds options which can bring them profit. Though this type of mutual fund can bring in substantial profit, a certain risk factor it associated with it that cannot be neglected.
- Balanced funds
This particular bond has been introduced to provide a balance of security, income and capital accumulation. The feature of this type of bonds is that they have 60% equity and 40% income.
- Equity Funds
The equity funds are formed with the objective to classify funds based on the size of the companies.
- Global/ International funds
It increases the diversification as it invests in stocks/ shares all around the world. However, they are more volatile and prone to political risks than the other types of mutual funds.
- Speciality funds
This type of mutual fund focuses on the broad diversification so it can generate large profits. Despite of the percentage of high returns, there’s a possibility of collapse in this sector.
- Index funds
It passively manages funds and mainly replicates the performance of a larger market. One of the characteristics of this market is lower fees from the investors as its main priority is to replicate the larger scene.
- Exchange Traded funds
These are popular investment pools that employ a wide number of strategies. The main feature of this particular mutual fund is it versatility and convenience.
Advantages of Mutual Fund
Now, as you are interested in investing on mutual funds you might be willing to know every detail about it before settling on a decision. Here are the advantages of investing on mutual funds that you would like to know.
- Professional management –
A professional investor takes all the troubles of doing careful research skilful trading. So, it becomes advantageous to not pick stocks and manage investments. A mutual fund can be a good way to invest money as one does not have to worry much about handling the portfolios with expertise, or having knowledge about the information only the professional companies have. It is also an inexpensive way to invest on something that would reap you good profits as you would get a professional who would make and monitor your investments.
- The simplicity –
It is a very straightforward process to have a mutual fund. The in-house firms and companies generally have their own in-house mutual funds where one can investment in a bare minimum amount. Also, many of the companies provide automatic purchase plans whereby $100 can be invested as minimum sum on a monthly basis.
- Diverse nature –
By investing in mutual fund, you get the opportunity to share your risks in different holdings. This could have been a difficult process had you have invested in owning individual stocks or bonds. Therefore, here, you do not stand at the risk of losing all your money in one source in case of any mishaps. Even if, you fail to achieve the sum, you are probably in a position to regain the loss from other assets. This is because trusted and large financial companies generally have a diverse pool of investment that makes your chance resisting shocks in a better manner.
- Transparency –
One is always willing to look for the companies which have a fair transparent policy. Most of the time, the companies are subjected to thorough accountability and fairness so that the investors do not back out from taking any decisions.
- Economies of scale –
Investing in a mutual fund scheme can be a good idea as companies like this make transaction in large amounts of securities at a time. This particular act lowers the transaction costs for the securities. Not only this, but a large investors stands at a position to take certain assets and more benefits that a small investor would generally do.
- Variety –
Nowadays, the mutual funds have a variety of asset classes along with strategies. This helps the investors to get their hands on numerous other foreign assets, commodities and real estate other than just stocks/ bonds.
Therefore, as you can see, investing on mutual funds can have lot of advantages and you can enjoy the enhancement of your investment without much worrying.
Disadvantages of Mutual Fund
Now, as you have taken an insight into the benefits of investing on mutual funds, you must check the disadvantages as well which would give you a fair understanding of the scenario. Down below are the disadvantages –
- Management that is mostly active –
There’s a debate on whether the management is efficient in collecting stocks than any other investors without that knowledge. The management takes active decision and even if the fund fails to gain money, the manager gets a steady income. The actively managed funds are costly but are popular due to the passive index funds.
- Dilution –
As you know, diversification of funds have beneficiary effects. However, this can also turn out to be a disadvantage and can bring poor returns. This is because higher returns on fewer investments can bring less or no results to the overall return. Moreover, dilution can also occur when the company has successful fund growing and is becoming too big. This often becomes a trouble as the manger couldn’t look for ways to find a more appropriate investment method where the new capital can be effectively utilised.
- Taxes –
You may have to face a capital gains tax which it is generated when the manager sells there security. So, investors need to be careful while investing on this field.
- Costs and fees –
Investing on mutual fund can be a bit daunting for many as it may cost a higher sum due to the creating, distribution and effective running of the entire company. Moreover, the cost it needs to bear the salary of the manger or the quarterly statements can call for more monetary needs. This can put a burden to the investors that would ultimately become a negative aspect of investing in mutual fund.
- Cash Drag –
A substantial amount in cash is required by the mutual fund which helps in redemption of share. A large amount of portfolio cash is also required to accommodate withdrawals and maintain liquidity. This occurrence is called cash drag as the cash invested earns no actual return.
These challenges mentioned above can give you a fair idea about the way mutual fund works and give you the extra information to gauge its intricacies. However, by balancing both the sides, one can find more advantages over the disadvantages.
How should you invest in mutual funds to gain maximum profit?
Now, if you are planning to invest in mutual funds, you might well have a look at the ways which can bring you more profits.
- Investing in mutual funds which is understandable
While taking the first step towards the investment, it is pivotal to understand the all the basics of how the company works and its policy. You should have a clear knowledge about the specificity, the underlying holdings, the risks attached to the investment strategy, etc. All these answers to these questions can give you a clarity which keeps things simple and understandable for you.
- Create a long term scenario
You can expect a fair return if you think at in at least for a term of 5 years or more. The landscape of mutual funds can show upheavals many a time which may lead you to lose faith in the profit making. A loss of even 50% can be noted sometimes, which you can see as a major drawback.
However, these are common matters which constantly happen in this field. Many a time, investors become emotional and sell the stocks at the worst moment. But steps like this can bring nothing but loss. This is the reason one needs to be patient and wait for the best opportunities.
- Considering a reasonable pay
Apart from investing an amount to the mutual fund, it is important to consider a reasonable sum for other costs. Everything from tax to income should be measured efficiently so that you can track and get the exact return for your pay.
Ways how investors gain returns
- Income is generally earned from the dividends on the invested stocks and interest on bonds. Funds are also important as it gives a choice to the investors to check for redistribution and reinvest the sum in further markets.
- The funds increase in price if the fund holder increase in price but is not sold by the manager. One can always sell it in the times of need to get profit out of it.
- The fund has a capital gain in case the fund sells securities that have increased in price.
Now, as you can have a fair idea about how the mutual fund market works, you can take a better step towards enhancing your profit. Check all the lists and take a decision after it gets fitted into the box. Moreover, you can also take an analysis on the entire market; understand the nitty-gritties before investing a lump sum in this market. It is essential to note that mutual funds have been subjected to different types of fraudulence that has caused severe problems to the investors. However, investing on something after doing a background check can always be a good idea and a proper measure to dodge losses.
Michelle Johnson is an MBA from Harvard Business School. She completed her degree with flying colors and has an experience of six years in her bag as an analyst. She has also helped a lot of students make important career decisions in their lives. Presently, she has also signed up in the online platform to help students use her experience and excel in life.