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Mutual Funds
When you invest in a mutual fund, your money is pooled with money from other investors to buy a portfolio, or group of stocks, bonds or other investments. Most mutual funds are open-end funds, which means they typically sell as many units as investors want to buy and repurchase any units that investors want to sell.
There are three major groups, or types, of mutual funds:
- Equity funds buy shares of companies
- Bond funds buy bonds issued by companies, governments or agencies
- Money market funds buy very short-term bonds and other loans (that typically are repaid within one year)
Besides the above, there are a host of other fund types, including those that invest into both equity and bonds and those that invest into international equity and bonds. Each fund group also has a number of subcategories, based on narrower distinctions, such as, in the way the fund invests. For example, some equity funds invest almost exclusively in small-company stocks and other funds focus on large-company stocks.
Goal-oriented investing
Each fund has a specific investment objective, which is the goal it strives to meet by making particular types of investments. For example, an equity stock fund whose objective is to provide a combination of gradually increasing prices and regular income might buy stocks issued by large companies with strong reputations and a history of paying regular dividends.
As an investor, you need to be aware that funds with different investment objectives have different levels of risk. An equity fund that invests primarily to benefit from increasing stock prices is much more likely to move up and down in value relatively quickly than a bond fund that invests for regular fixed income.
You can find an assessment of the risk a fund poses as well as its investment objective in its offer document, an official document that also states the fund's investment objective, fees and past performance. You should familiarize yourself with a fund's scheme instruction document (SID) before you invest any money in that fund.
Advantages of mutual funds
Mutual funds can be an attractive choice for both new and experienced investors for a number of reasons:
Affordability
You can buy mutual fund units for a small sum and keep adding to it in small amounts.
Diversification
By buying units of a mutual fund, you're investing in all the different stocks or bonds the fund owns. Owning many investments instead of just a few can help protect you against losses you might have if the ones you had selected happened to fall in value.
Liquidity
You can convert your mutual fund units into cash at any time by selling them back to the fund. The selling price is determined by the fund's net asset value (NAV) and may be higher or lower than the amount you originally paid.
Professional expertise
A professional manager runs each fund, making all buy and sell decisions.
Some words of caution
As with all investments, there are risks you encounter when you purchase mutual funds. For example, results are not guaranteed. That means you can lose money as well as make money, even though your funds are managed by experts.
Mutual fund fees
As with all products and services, different companies charge different prices for what they offer. Mutual funds are no exception, and you should evaluate the fees that various funds charge before choosing among them. The more you pay in fees, the more the fund must earn for you to realize a strong return. You can find most of the information on what the fees are and how they are paid in the fund's Scheme Information Document (SID), on the fund company's website or from your investment adviser.
Total Expense ratio
You pay a percentage of your mutual fund unit value for the transaction and other expenses the fund has incurred in buying and selling investments and other operating expenses. Since this is a recurring rather than a one-time fee, it's especially important in evaluating a fund's cost. Some funds trade underlying investments frequently while others, such as index funds, trade only when the securities in the index change.
Investment management fees
Included in the total expenses is an element of investment management fee that is paid to the fund company for managing the mutual fund. This is a percentage of your portfolio value.
Loads
You may pay a percentage of the amount you invest when you buy units in a fund (known as entry load) or you may incur exit loads if you sell your units within a certain time period after you purchase them . Other funds, called no-load funds, do not have sales charges. Entry and exit loads vary across various funds and fund types. You should familiarize yourself with these charges by reading the SID of every fund that you consider for investment . |
