What exactly is a Mutual Fund?
A mutual fund is basically a big pool of money that many individuals with similar goals or interests contribute to, that allows the money manager to invest the pool of funds into assets such as stocks, bonds and other securities that will help meet the fund’s and your investment objectives. Mutual funds allow individuals to invest their funds with easy accessible diversification through professional money managers. When you invest your money into a mutual fund you buy individual share of this big pool of money, giving you a slice of the pie. Investment decisions are made by the portfolio management team, where they decide the investment allocation and what specific securities will make up this investment pie. They make sure all securities the fund invests in are in line with the shareholder’s (that’s you!) objective and will help you potentially reach your financial goals.
Why are mutual funds good investment vehicles?
Mutual funds allow you to easily diversify your funds and investments. By investing in different industries, companies and global regions, you can spread the risk over a larger number of different securities; thereby potentially lower your portfolio’s volatility and risk of loss. Mutual funds on average invest in 25-100 different securities, which help spread the risk of loss and help increase the probability of achieving a higher return, in accordance with the fund’s investment objectives.
Funds allow you to gain access to experienced, successful money managers that are the best of the best! This provides peace of mind knowing that someone is watching over your investments while you are focusing your attention to whatever it is that you do best. Most fund managers are graduates of top business and finance schools from around the world, and/or hold highly regarding designations such as the Chartered Financial Analyst (CFA) designation (CFA Charterholders). Fund managers typically have ten years or more of experience in analyzing and selecting investments, which helps them to be successful!
Mutual funds can help you save time by conducting research and due diligence. Mutual funds analyze company financial statements, company and industry strategies, and speak with the company’s management, customers, suppliers, and competitors. By understanding each company’s strategy and the industry in which they compete in, the manager can select the best companies to invest in given a certain level of risk for the best return opportunities.
One additional benefit that funds provide is the ease to which you can invest. Mutual funds can be bought via the mail, telephone, in an office, or via the internet. You can mail in a check, or transfer money electronically over the phone or online. And, in the event you need to access your funds, it is just as easy to make a withdrawal. Mutual funds sure do make it easy!
A Word of Caution:
Mutual funds are great investment vehicles; however before choosing to invest in a fund, one must also be aware of the following:
- Returns are not guaranteed. Your investment will experience some fluctuations in value – volatility. By investing in solid, strong mutual funds for the long term, chances are you will earn a positive rate of return than you otherwise would have had you left your money in a saving account. Slow and steady wins the race!
- Be aware of the fees that funds charge. Not all funds are created equal, and neither are their fees. Some funds charge very high annual fees, in addition to possible loads. Be aware!
- Some funds provide taxable distributions that you must report at the end of the year. Fund managers actively manage their portfolios, meaning they buy and sell as they see a need. If a security is sold for a profit, this profit must be distributed to the shareholders (that’s you) in addition to any dividends that are paid and received.
A successful investor is an educated one. By understanding how mutual funds work, you are better positioned to select the right investments for you to help achieve all your financial goals. Stay informed and you are well on your way to achieving financial success and making dollars and “cents.”