What are mutual funds?
Mutual
funds refer to a company that pools funds from investors and invests them in
securities such as bonds, stocks, and short-term debt. The merged mutual fund
holdings are typically known as its portfolio. Any investor can buy shares in
mutual funds. And each share depicts an investor’s part of fund ownership and
the income it generates.
Why do people prefer mutual funds for
investment?
Mutual
funds is one of the most popular choices among investors because they offer
multiple helpful features, some of which are described below:
●
Professional Management: Mutual fund managers
generally research for you before investment. They select the most valuable
securities and monitor their performance.
●
Diversification: Mutual funds typically
invest in a wide range of industries and companies, which helps to lower the
risk if any company fails.
●
Affordability. Most mutual funds
typically set a relatively low amount for initial investments and succeeding
purchases.
●
Liquidity. Mutual fund investors
can quickly redeem their shares anytime for the current net asset value plus
redemption fees.
Types of mutual funds:
There
are mainly four types of mutual funds- money market funds, stock funds, bond
funds, and target date funds. Each type of fund has different risks, features,
and rewards. Here we have discussed each type in detail:
- Money
market funds: These funds have relatively low risks. According to
law, they can invest only in high-quality, short-term investments issued
by state, federal, and local governments.
- Bond funds: These typically
have more risks than the money market fund as they aim to make higher
returns. As there are various types of bonds, the rewards and risks of
bond funds can vary dramatically.
- Target
date funds: The target date funds are also known as lifecycle funds. These
funds hold a mix of different stocks, bonds, and other investments. Over a
specific time, the mix gradually locomotes according to the fund’s
strategy. Moreover, these are designed for investors with particular
retirement dates in mind.
- Stock
funds: Stock funds mainly invest in corporate stocks, including growth
stocks, value stocks, etc. However, not all stock funds are similar; the
main differences are:
●
Income funds invest in those stocks that can pay regular
dividends.
●
Growth funds focus on stocks that have the potential for
above-average financial returns.
●
Sector funds specialize in a certain industry segment.
●
Index funds follow a particular market index.
What are the benefits of mutual
funds?
Mutual
funds offer skilled investment management and better potential diversification.
In addition, they offer three beneficial ways to earn profit:
●
Dividend Payments: The funds earn income
from interest on bonds or dividends on stock. The fund then provides the
shareholders with nearly all the income and fewer expenses.
● Capital Gains Distributions: The
securities price in a fund may rise. When a fund sells those securities that
increase in price, the fund will get a capital gain. The fund distributes these
capital gains to investors at the end of the year.
●
Increased NAV: If the value of a fund's
portfolio rises after deducting expenses, then the fund's value and its shares
increase. The higher Net Asset Value reflects the higher value of the
investment.
The risk associated with mutual
funds:
All
funds hold some level of risk. With mutual funds, an investor may lose some or
all of the invested money as the securities owned by a fund can move down in
value. The dividends or interest payments also differ as the market conditions
change. However, the fund's past performance is not as important as investors
think because it can not predict future returns. But past performance can tell
about how stable or volatile a fund has been over a while. And the investment
risk will be higher if the fund is more volatile.