A fund managed by an investment company which lifts up capital from financier and invests in a pool of assets. Just like a listed company the mutual funds also raise money by selling shares of the fund and purchase various investment securities such as stocks, bonds and money market instruments. In return to the investment in fund the investors become equity holders and called shareholders in each of its underlying securities. Depending upon the performance of the fund the price of the share will remain fluctuating on daily basis and shareholders are also free to sell their shares at any time they feel appropriate.
Mutual fund investments showed a tremendous improvement over the last twenty years particularly in advanced countries. Most people now believe that it’s better to invest in mutual funds than simply letting their cash waste in banks. The reason of such a large attraction is also due to its appeal that every common person can understand the theory of mutual funds in the sense that a group of people bring together their savings and invest in a joint venture. Each individual holds the share of his/her ownership and receive the return. The institutionalization of this concept takes the form of mutual fund where some trustees acknowledge their responsibility towards the safety and security of the money and also that of payment of return to those who provided funds.
There are three ways of earning money from mutual funds.
• Dividends on stocks and interest on bonds.
• Capital gains due to increase in the price of the fund securities.
• If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. One can then sell one’s mutual fund shares for a profit.
The shareholders are always given a choice to receive a check for their earnings or to reinvest in the fund to increase the holding and future profits.
Advantages of Mutual Funds
• The fund as a professional manager manages the invested money with a lot of expertise and therefore provides the investors a secured platform to earn profits over the invested funds with out disturbing their busy schedules.
• Mutual funds invest money in diversified portfolio therefore reduce the risk and maximize the profit.
• Because mutual funds buy and sell large amount of securities at one time therefore provides economies of scale through reduction in transaction costs.
• Shares in mutual fund can be converted into cash very easily.
• Buying a mutual fund is quite easy and shares are available in small denominations for lower and middle class investors.
Disadvantages of Mutual Funds
• The management’s incapability to pick profitable stocks due to lack of creditability in the investor class.
• Running a mutual fund is an expensive job and high costs of fund have to be absorbed by the investors.
• Due to too much diversification the good returns from profitable securities are often off set by the losses or dilutions in the unprofitable ones.
• Investors have to pay capital gain taxes.
It’s possible to diversify the risk associated with mutual funds. Some funds are less risky and some are more. But it is not feasible to diversity all risks allied with mutual funds. The higher the risk the greater is the return and vice versa.
Types of Mutual funds
Money Market Funds
A short term debt instrument usually treasury bills and are very safe investment. Due to low risk the return associated with this kind of fund is also low but there is almost nil chance of loosing the principle.
The purpose of these funds is to provide steady stream of income to the investors. Risks and return are low but a very safe place to park the idle money.
Balanced funds are meant for to provide a balance of risk and return to the investors. The funds are diversified in such a way that investors can reap the fruits of high returns and capital appreciation and at the same time can rescue some investment against higher risks or loss.
Money to be invested in stocks and poses high risk of losses and at the same time provides very high returns to the investors. These funds are particularly attractive to the risk takers.
International and Global Funds
To diversify the political, legal, and economic risks these funds invest inside and outside the country. Funds that invest only outside the country called international funds and that investing in home and world wide are called global funds.
To concentrate on certain segment of the economy specialty funds investments are made. These funds are extremely popular among the investing community and pay high returns and forgo broad diversifications.
Most of the mutual funds companies charge fee which consists of ongoing yearly fees for keeping the funds invested and transactions cost when the investor buy or sell securities. But a problem arises when the mutual fund companies through financial jargon hide costs or make it more complex for the common investors to understand.
Shares in the mutual fund can be purchased by contacting the fund company directly, or from brokers, banks, financial institutions, and insurance agents. To purchase funds from any party other than the company directly one has to pay sales charge called load. In advanced countries where efficient money and capital markets exist the term of mutual fund supermarkets is also used for the mutual funds companies, brokers, and institutions dealing in mutual funds purchase and sale.
This is important to set an objective before being investing in a mutual fund due to the fact that funds are available with differing attributes and are specifically designed to meet the requirements of the masses. For example if the investor is planning to secure old age than long term capital gains and returns are preferable or if he/she wants current regular income than short term income bonds should be preferred. Identifying a goal is important because it will help in choosing the right fund for the task. Another very important area of consideration is that the person wanted to invest in mutual fund must evaluate his/her risk preference or risk tolerance. This evaluation would also help in deciding the right fund in accordance with the risk predilection or forbearance.