Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other investments. Managed by professional fund managers, mutual funds allow individual investors to access a broad array of investments that would be difficult to replicate on their own due to the capital required. This resource pooling enables investors to diversify, reducing the risk of loss if any single investment performs poorly. Mutual funds are popular among investors for several reasons, including professional management, diversification, and accessibility.
Key features of mutual funds
Professional management: Mutual funds are managed by professional fund managers who make investment decisions on behalf of the fund. These managers research and select securities to meet the fund’s investment objectives, monitor performance, and make adjustments as needed.
Diversification: By investing in a wide range of assets, a mutual fund can spread out risk. A mutual fund can hold dozens or even hundreds of different securities, making it less likely that a single underperforming investment will significantly impact the overall performance of the fund.
Accessibility: Mutual funds allow investors to start with relatively small amounts of money and still gain access to a professionally managed, diversified portfolio. This makes mutual funds an attractive option for new investors and those with limited capital.
Liquidity: Mutual fund investors can easily redeem their shares at the current net asset value (NAV), which is calculated at the end of each trading day. This provides a level of liquidity not always available with certain other types of investments, such as real estate.
Types of mutual funds
Mutual funds come in various forms and below are a few examples.
Equity Funds: These funds invest primarily in stocks and aim for growth over time. They can vary widely, focusing on specific sectors, regions, or investment styles (e.g., value vs. growth).
International/Global Funds: These funds invest in securities from markets outside the investor’s home country or globally. They offer diversification beyond domestic markets but come with their own risks, such as currency fluctuations and geopolitical factors.
Regional Funds: Regional funds focus their investments on a specific geographical region, typically one that involves several countries, e.g. South-East Asia or Eastern Europe. They can for instance invest in companies and other endevours based within the region or in companies that are based somewhere else but derive a significant part of their revenue from the region.
Emerging market funds: These funds focuse their investments on emergin markets (developing countries) around the world.
Fixed-Income Funds: Also known as bond funds, these invest in government and corporate debt securities. They aim to provide investors with regular income and are generally considered less risky than equity funds.
Balanced Funds: These combine stocks and bonds to provide both growth and income. The mix often adjusts based on market conditions or as investors approach their investment goals.
Index Funds: These funds aim to replicate the performance of a specific index, such as the S&P 500, by investing in the same securities in the same proportions as the index.
Money Market Funds: These funds invest in short-term debt securities and are considered very low risk. They offer investors a place to park cash with a minimal return.
Value Funds: The fund managers will invest in stocks they consider undervalued. Typically, such companies have low P/E ratios and low price-to-book ratios.
Considerations for investors
- While mutual funds offer several benefits, they also come with costs, such as management fees and other expenses, which can vary significantly from one fund to the next.
- While diversification reduces risk, it does not eliminate it, and the value of mutual fund shares can fluctuate. Investors should carefully consider a fund’s investment objectives, risks, fees, and expenses before investing.
Earning money by investing in a mutual fund
As an investor, you can normally earn returns from a mutual fund in three major ways:
Dividends or interest income: When dividends are paid on shares owned by the fund, the fund can distribute the money to the fund share holders. When interest is paid on bonds and other debts owned by a fund, the fund can distribute the money to the fund share holders. In these two situations, fund share holders will often be given the choice of either getting paid outright or use the money to buy more shares in the fund.
Portfolio distributions: If the mutual fund sells something with a profit, the fund realizes a capital gain. The fund can pass on this capital gain to the fund share holders in the form of a distribution.
Capital gains: If the fund shares increase in market value (compared to when you bought them), you can sell fund shares and make a profit.
When you compare different mutual funds, trying to decide which ones to invest in, you will most likely come across figures for each fund’s “total return”. This denotes the net change in value over a specific period of time, and can be positive or negative. It is typically shown for 1 year, 5 years and 10 years, and also from the first day of the fund.
Conclusion
Mutual funds are a cornerstone of many investors’ portfolios, offering an accessible way to achieve diversification and access professional management. Whether seeking growth, income, or a balance of both, there is likely a mutual fund that aligns with nearly every investor’s goals. As with all investments, due diligence and a clear understanding of one’s own investment strategy are key to selecting the right mutual fund.