Mutual Funds are now-a-days the most recommended investment tool by financial experts. So it is important to clear our doubts and learn basics of it.
Mutual Funds are actually the pooling of funds by investors so as to invest in variety of securities like shares, bonds, etc.
It is managed by money managers who allocates funds from their clients(Fund investors) and produce capital gains.
Mutual funds allows investors to manage their portfolio containing shares, debts, etc in proportionate manner. These funds are driven by the movement of market. Just like the ordinary shares, mutual funds can be purchased or sold at the market value or Net Asset Value(NAV) on the particular date.
More fact about Mutual Funds:
Mutual Funds are the companies who deals in investment. When you are buying Mutual Funds, you are actually buying the shares of Mutual Fund company. From the money allocated from public, Mutual Fund company buys securities from other companies. The value of mutual funds depends upon the performance of the securities of that company.
As Mutual Fund company holds large number of securities, so investors gets advantage of buying the funds at lower cost with diversification.
Advantages of Mutual Funds:
Diversification: A diversified portfolio has securities with different capitalizations and industries, and bonds with varying maturities and issuers. Buying a mutual fund can achieve diversification cheaper and faster than through buying individual securities.
Economies of Scale: Mutual funds also provide economies of scale. Buying shares of one company can cost you more than buying mutual funds. At the same cost of buying shares, you can buy more quantity of mutual funds.
Easy Access: Trading on the major stock exchanges, mutual funds can be bought and sold with relative ease, making them highly liquid investments.
Individual-Oriented: All these factors make mutual funds an attractive options for younger, novice and other individual investors who don’t want to actively manage their money: They offer high liquidity; they are relatively easy to understand; good diversification even if you do not have a lot of money to spread around; and the potential for good growth.
Limitations of Mutual Funds:
Fluctuating Returns: As mutual funds are governed by movement of market. So just like the ordinary shares, their returns are always fluctuating. Investors are required to check the performance of their securities, so as to take wise decisions!
Cost: Mutual funds are cost effective. But costlier option at managing them. Mutual funds provides performance management, but at a cost. It reduces the net earning of investor.
Diworsification: It is a type of syndrome which arises when the portfolio of investor becomes more exposed to risk. When the investors buys too many funds, which are similar in nature. Then it reduces the advantages of diversification, for reducing risk.
Lack of Transperacy: One of the disadvantage which leads to diworsification is that fund manager or companies not always tells the main purpose of fund’s allocation. The advertisements of funds can mislead the investors.
Trouble in researching: It is difficult for investors to research on different types of funds. Investors are not provided the sources to verify the P/E Ratio, Earning per Share ratio, etc.
Types of Mutual Funds:
Money Market Fund: These funds invest in short-term fixed income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are generally a safer investment, but with a lower potential return then other types of mutual funds.
Fixed Income Fund: Just like Money Market Fund, they are safer. Here the money is invested in investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds and high-yield corporate bonds. They aim to have money coming into the fund on a regular basis, mostly through interest that the fund earns.
Equity Funds: These funds invest in stocks. These funds aim to grow faster than money market or fixed income funds, so there is usually a higher risk. You can choose from different types of equity funds including those that specialize in growth stocks (which don’t usually pay dividends), income funds (which hold stocks that pay large dividends), large-cap stocks, mid-cap stocks, small-cap stocks, or combinations of these.
Balanced Funds: These are most preferred by those investors who wants to stay safe in these market fluctuations. These funds invest in a mix of equities and fixed income securities. They try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds. These funds can be further classified into two nature: Aggressive funds having more stocks and less bonds. Other one is Conservative funds with more bonds and less equity shares.
Index Funds: These funds aim to track the performance of a specific index. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.
Specialty Funds: These funds focus on specialized mandates such as real estate, commodities or socially responsible investing. For example, a socially responsible fund generally invests in companies dealing with activities relating to environment protection, health care, etc.
Fund-of-Funds: These funds invest in other funds. Similar to balanced funds, they try to make asset allocation and diversification easier for the investor.