MUTUAL FUNDS
Mutual Funds
What are mutual funds
A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the income it generates.
Why do people buy mutual funds
Mutual funds are a popular choice among investors because they generally offer the following features:-
- Professional Management - The fund managers do the research for you. They select the securities and monitor the performance.
- Diversification - or “Don’t put all your eggs in one basket.” Mutual funds typically invest in a range of companies and industries. This helps to lower your risk if one company fails.
- Economies of Scale - Mutual funds have the resources to invest in a wide range of securities, which can be more cost-effective than individual investors.
- Liquidity - Mutual fund investors can easily redeem their shares at any time, for the current net asset value (NAV) plus any redemption fees.
- Tax Efficiency - Mutual funds are designed to be tax-efficient, which means they can help you keep more of your money.
- Affordability - Most mutual funds set a relatively low dollar amount for initial investment and subsequent purchases.
What types of mutual funds are there
Most mutual funds fall into one of four main categories – money market funds, bond funds, stock funds, and target date funds. Each type has different features, risks, and rewards.:-
- Money Market Funds - These funds invest in low-risk, short-term debt securities, such as commercial paper and treasury bills. They are designed to provide liquidity and preserve capital.
- Bond Funds - These funds invest in a variety of bonds, such as government and corporate bonds. They can offer a regular income stream and relatively lower risk.
-
Stock Funds - These funds invest
in a variety of stocks, such as individual stocks, stock mutual funds, and
exchange-traded funds (ETFs). They can offer the potential for long-term growth
and income.
invest in corporate stocks. Not all stock funds are the same. Some examples are:
- Growth funds focus on stocks that may not pay a regular dividend but have potential for above-average financial gains.
- Income funds invest in stocks that pay regular dividends.
- Index funds track a particular market index such as the Standard & Poor’s 500 Index.
- Sector funds specialize in a particular industry segment.
- Target Date Funds - These funds automatically adjust their asset allocation based on your retirement date or another specific date. They are designed to provide a diversified portfolio and minimize the need for frequent rebalancing.
What are the benefits and risks of mutual funds?
Mutual funds offer professional investment management and potential diversification. They also offer three ways to earn money:-
- Capital Gains Distributions - The price of the securities in a fund may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, the fund distributes these capital gains, minus any capital losses, to investors.
- Dividend Income - Many mutual funds invest in stocks that pay regular dividends. These dividends are distributed to investors.
- Interest Income - Some mutual funds invest in bonds or other debt securities that pay interest. This interest is distributed to investors.
- Tax Benefits - Mutual funds can provide tax benefits to investors. For example, some mutual funds invest in municipal bonds, which are tax-free. This means that the interest earned on these bonds is not subject to federal income tax.
- Liquidity - Mutual funds offer liquidity to investors. This means that investors can sell their shares in the fund at any time and receive their money back.
- Professional Management - Mutual funds are professionally managed. This means that a team of investment professionals manages the fund and makes investment decisions on behalf of investors.
- Increased NAV. - If the market value of a fund’s portfolio increases, after deducting expenses, then the value of the fund and its shares increases. The higher NAV reflects the higher value of your investmen
All funds carry some level of risk. With mutual funds, you may lose some or all of the money you invest because the securities held by a fund can go down in value. Dividends or interest payments may also change as market conditions change.
A fund’s past performance is not as important as you might think because past performance does not predict future returns. But past performance can tell you how volatile or stable a fund has been over a period of time. The more volatile the fund, the higher the investment risk.