What is mutual fund?
Mutual fund can be defined as a collection of stocks or bonds where a group of people invests their money in stocks, bonds, and other securities. How will you be profited? The investor in a mutual fund, own a portion of the fund and shares that portion in any increases or decreases in the value of the fund. Here, profits are earned from dividends on stocks and interest on bonds. The income received over the year is passed to the fund owners in the form of a distribution and if the fund sells securities that have increase in price, the fund has a capital gain which is passed as gains to investors in a distribution. If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price and then can be sell with profit.
Different types of Mutual funds:
Which is right for you? It depends on a number of things including your investment time horizon, risk tolerance and financial circumstances. Basically they are two types of mutual funds OPEN ENDED (or) OPEN in which investors may purchase units from the fund sponsor or redeem units at the valuation promised in the fund documents, usually on a daily basis. CLOSED- ENDED (or) CLOSED are traded as financial securities, once they are issued, holders must sell their units on the stock market to receive their funds back. Mutual funds are generally categorized according to risks and there returns some of them are:
1) Money Market Funds: It consists of short-term debt instruments such as commercial paper, certificates of deposit, Treasury bills and other highly liquid and stable securities.
It has very low expense ratios and interest is credited monthly to shareholders.
2) Bond/Income Funds: Designed to produce current income for shareholders by investing in corporate and government securities or municipal bonds, which are issued by state or local government and provide tax-free income.
3) Asset Allocation Funds/ Growth and Income Funds: They seek growth of capital as well as current income. These funds invest mainly in the common stock of companies with a solid growth and payment history.
4) Balanced Funds: Objective of these funds is to provide a balanced mixture of safety, income and capital appreciation. The strategy of balanced funds is quiet similar to asset allocation fund.
5) Global/International Funds: Global is mixture of stocks or bonds throughout the world including the US and International is mixture of stocks or bonds throughout the world excluding the US.
6) Stock Funds: Seeks to provide growth of investment and appreciation of the share price. They invest in stock of companies with potential for growth, stocks of different market capitalization, industry sectors, and foreign stocks.
7) Specialty Funds: This type of mutual fund forgoes broad diversification to concentrate on a certain segment of the economy.
A Sector fund concentrates on specific sectors of the economy such as financial, technology, health, etc. It seeks to provide growth of investment that is usually non diversified.
A regional fund makes it simple to concentrate on a specific area of the world. Benefit of these funds is buying stock in foreign countries will become easy which in general is difficult and expensive task.
Socially-responsible funds (or ethical funds) invest only in companies that meet the criteria of certain guidelines or beliefs and do not concentrate on industries such as tobacco, alcoholic beverages, weapons or nuclear power.
Some details on fees and cost:
Main reason why majority of funds end up with sub-par performance is due to cost. So how is the investor charged? Fees can be broken down into two categories:
1. A constant yearly fees to keep you invested in the fund.
2. Transaction fees paid when you buy or sell shares in a fund
The ongoing expense of a mutual fund is represented by the expense ratio which is composed of the following: The cost of hiring the fund managers known as management fee, and Administrative costs which include necessities such as postage, record keeping, customer service, cappuccino machines, etc
Fee also depends on whether its load type or no-load type. By the way what are loads? Loads are just fees that a fund uses to compensate brokers or other salespeople for selling it and they are classified further into:
Front-end loads: These are the simple type of load; fee is paid when you purchase the fund.
Back-end loads (also known as deferred sales charges): Bit more complicated and in such a fund you pay a back-end load if you sell a fund within a certain time frame
What are no-loads? A no-load fund sells its shares without a commission or sales charge
Depending on all these conditions a cost or fee is charged on an investor.
Tips to consider while investing in mutual funds:
Consider factors such as the fund's sales charges, fees, and expenses; the taxes to pay when you receive a distribution, the age and size of the fund and if it is new go for proven track record, the fund's risks and volatility and recent changes in the fund's operations. Understand the prospectus thoroughly before you invest.
Tips after investing:
Distribute your investment money among several funds (as the market is fluctuating),
Plan to leave your money in the fund for several years which will allow benefiting from the market’s long-term growth.
Make regular monthly deposits which will help average out the stock markets daily fluctuations.
If you select a fund with a load try to get one with a back-end load. With a back-end load your entire investment is earning. With a front-end load, a portion of your initial investment is deducted immediately, leaving less to earn.
Keep records and know how much you invested and on what date. It will help you keep track of how much you have earned. Don't be alarmed over short term losses or gains, but if over a year it's performing poorly, move your money.