Beginners guide to mutual funds investment

From business channels to stock market journals, mutual funds are attracting the interest of a large number of investors. The phrase “mutual fund investments” might sound like a complicated concept, however, once you understand the basics it all makes sense.

Key Points:

  1. Mutual funds are highly diverse in nature. That is why they attract a lot of investors.
  2. A few of the major types are bond funds, stock funds, and balanced funds.
  3. Mutual funds can be traded only once per day.

Mutual Funds Basics

Assume that there are numerous investors and all of them have invested their money in a particular fund. This fund collects all the money and pools it in one spot. It then uses this money to buy all kinds of assets including commodities, stocks, bonds and real estate. Now person A (one of the investors) buys shares in this fund. These shares bought by A now represent an ownership interest in the assets bought by the fund. This is what mutual funds are.

Mutual funds are highly diverse in nature. That is why they attract a lot of investors. A single investment can include shares of numerous assets. Therefore, an individual investor looking to make money does not need to search for various forms of investments. Mutual funds also tend to be extremely fluid. That means it is comparatively easier to buy and redeem units in mutual funds than it is to buy and liquidate other investments like real estate.

Types of Mutual Funds

There are multiple kinds of options for investment in mutual funds. A few of the major types are bond funds, stock funds, and balanced funds. Bond funds hold fixed-income securities as assets. These bonds pay regular interest to their holders. The mutual fund makes distributions to the holders of this interest.

The stock funds make investments in shares of different companies. They rely on the situation of the stock market as well as the status of the companies for dividends. Stock funds work on definite strategies for investments in the shares of a company. These may include IPO value, Market Value, Brand Strength etc. The companies are distributed on the basis of market capitalisation, which is basically the gross value of a company’s outstanding shares. Stock funds define them as large-cap, small-cap and mid-cap stocks. Large-cap stocks are companies whose values range in billions of dollars. Hence, their stocks do not show much volatility when it comes to rise and fall of values.

Balanced funds are a mixture of bonds and stocks. Bonds can be best described as you loaning your money to a company and it paying you interest on the amount for the term of that loan. These are considered conservative investments because one can set the term and length of the bond and know exactly how much money you will get back at the maturity of the term. Generally, bonds are safer than stocks in terms of investment risk, and more often than not, the only way you could lose money on bonds is if a company defrauds you.

How can you trade mutual funds?

Mutual funds can be traded only once per day. If you engage in a trade to sell or buy mutual funds, your trade will be available at the next Net Asset Value which is calculated and posted a few hours after the market closes. The NAV is calculated by dividing the total value of all the assets in the portfolio, minus any liabilities, by the number of outstanding shares.

An investor can buy or redeem mutual funds directly from the fund. This is unlike stocks, where the buyer buys shares from a seller and a chain of buying and selling takes place. Hence, mutual funds always require a minimum investment which may vary from company to company.

What kinds of fees do Mutual Funds charge?

There are different kinds of fees that companies may charge depending on their policy and it is very important for an investor to understand the fees associated with the investment in their fund.

Some mutual funds may charge load fees, which actually reduces the expertise and compensates the time required for an investor to choose a fund. Front-end load is charged when an investor first buys units in the fund. A back-end load, also called a deferred sales charge, is charged if the fund’s units are sold within a certain time frame after first purchasing them. The back-end load is usually higher in the first year after buying the shares, but then goes down each year after that. For example, a fund may charge 3% if shares are redeemed in the first year of ownership, and then reduce that fee by 1% each year until year three when no fee is charged.

Loads and expense ratios can be a drag on the investment performance. Funds that charge loads have to outperform their benchmarks to justify the fees.

Wrapping Up

  • Mutual funds funnel money from investors in a pool and divert them into assets such as stocks.
  • Every investor who buys a share in mutual fund owns a share in the gross value of the assets depending on the value of investment he makes.
  • There are various kinds of mutual funds to choose from - stock funds, bond funds, balanced funds, etc.
  • Investors should be aware of different kinds of fees charged by the mutual funds and analyse the risk vs. return expectations for themselves keeping in mind that there are no risk-free investments in the stock markets and mutual funds.