In past articles, we’ve discussed ways to diversify your sources of income, given you some business ideas you can start from home, and even detailed what is specific and unique about blockchain. In this article, we want to discuss mutual funds and how you can turn them into a sustainable investment strategy. But let’s start by defining these terms. What are mutual funds?
To answer the question: “What are mutual funds?”, we must look at them as investment strategies that allow us to pool our money with other investors to buy a collection of stocks, bonds, or other securities that could be difficult to re-create. These are often called portfolios.
The price of the mutual fund, also known as its net asset value (NAV), is determined by the total value of the securities in the portfolio divided by the number of outstanding fund units. This price fluctuates based on the value of the securities held by the portfolio at the end of each business day. Note that mutual fund investors do not actually own the securities in which the fund invests; I only own fund units in the fund itself.
In actively managed mutual funds, decisions to buy and sell securities are made by one or more portfolio managers, supported by teams of analysts. A portfolio manager’s primary goal is to seek investment opportunities that allow the fund to outperform its benchmark, which is generally a broadly tracked index such as the Standard & Poor’s 500 (S&P500).
How do mutual funds work?
A mutual fund allows investors to pool money with a common investment objective and then invest the money in different asset classes based on the objectives of the investment strategy.
Mutual funds have certain advantages over direct investments. For example, maybe you don’t have the skills to understand the market trends yourself or you don’t have the time to watch the market closely. Mutual funds are a great alternative in this case as they are managed by professionals.
What are the best mutual funds in the market?
The purpose of our articles is educational, through the information we provide you we want to create a broad picture of the specificity and investment potential of mutual funds, so we will not come up with a “recipe” to highlight the best market mutual funds.
Many new investors do a quick Google search for the words “top 10 mutual funds.” Most new mutual fund investors ask some version of this question—to friends or colleagues or mutual fund forums—as they begin their investment journey. But the search for top strategies often confuses investors even more. Don’t get us wrong. We want to explain.
An online search would mostly lead you to some websites with ready-made lists. Most often, the investment strategies used by funds can be shortlisted based on their short term in the fund name. Some people never get beyond collecting top fund names because searching for top funds becomes their favorite pastime. A lingering doubt as to the veracity of the names always holds them back. It’s no wonder that many investors continue to visit mutual fund forums for validation years – even after they start investing.
When I did the research for this article, I looked for as broad a classification as possible, that’s why we focused on the programs offered by ETMutualFunds, a company that decided to publish a list of the top 10 categories of mutual funds. We’ve picked two out of five different categories of equity mutual funds—aggressive mix schemes with investments in large-cap, mid-cap, small-cap, and flexible-cap companies—that we think should be enough for novice fund investors.
Mutual funds vs. Actions
What is the difference between mutual funds and shares – to clarify this aspect, we will define, by comparison, the two investment strategies.
A share represents fractional ownership in an operation. A mutual fund raises money from many investors to invest in a combination of several stocks and bonds.
When you only invest in stocks, you can definitely make money, but it’s harder. You need to try to replicate the same returns you would get with a mutual fund, but you need a lot more capital to do it. Mutual funds give investors the option to invest in a diverse selection of companies. Experts agree that once you build a solid and well-diversified portfolio using investment vehicles like mutual funds, you can put some money aside to invest in stocks, but no more than 5%. Remember that when the company loses money, so do you because the value of the shares you own goes down. That’s why protecting yourself by diversifying is a very important part of investing.
Mutual funds vs. ETFs
What is the difference between mutual funds and ETFs – to clarify this aspect, we will define, by comparison, the two investment strategies.
Mutual funds and exchange-traded funds (ETFs) have a lot in common. Both types of funds consist of a mix of many different assets and are a popular way for investors to diversify. While mutual funds and ETFs are similar in many ways, they also have some key differences. A major difference between the two is that ETFs can be traded intraday like stocks, while mutual funds can only be purchased at the end of each trading day based on a calculated price known as net asset value.
Mutual funds in their current form have been around for nearly a century, with the first mutual fund launched in 1924. Exchange-traded funds (ETFs) are relatively new entrants to the investment arena, with the first ETF launched in January 1993; this was the SPDR S&P 500 ETF Trust (SPY).
In recent years, most mutual funds have been actively managed, meaning that fund managers made decisions about how to allocate assets in the fund, while ETFs are generally passively managed and track market indices or specific sector indices. This distinction has become blurred in recent years, as passive index funds account for a significant proportion of mutual fund assets under management, while there is a growing range of actively managed ETFs available to investors.
How do you buy mutual funds?
For most investors, mutual funds are a great way to build a diversified portfolio without too much extra cost or hassle. They typically hold hundreds if not thousands of different stocks, bonds, and other securities, giving you instant diversification. In the following, we will present you some steps that you must follow when you want to buy mutual funds.
How much should you invest initially? What is your investment objective?
If you’re saving for a short-term goal like buying a house or a car (within the next few years), a bond mutual fund might be a better option. Investors who need easy access to their money in the very short term should consider high-yield savings accounts, which offer greater liquidity and are federally insured up to at least $250,000.
How do I invest in mutual funds? What is the strategy I can apply?
Once you have identified your mutual fund investment objectives, you can choose funds with the right investment strategy tailored to your objectives.
- Long-term goals. Investing in mutual funds for the long term means you have decades to reach your financial goals. With this in mind, your mutual fund allocation should probably be 70% to 100% in equity mutual funds to position yourself for the greatest investment growth. You can specifically look for mutual funds labeled “growth funds” to invest in companies that are expected to grow faster than others. These funds carry more risk but also have a greater potential for large gains.
- Medium-term objectives. If investing heavily in stocks causes you anxiety or you have a goal that is within five to 10 years, you may want an approach that reduces the potential for rapid changes in the value of the investment. Balanced mutual funds invest in both bonds and stocks, offsetting some of the risk associated with stocks.
- Short-term goals. If you’re only a few years away from your goal, your focus should be on minimizing risk so you don’t lose money when you need to. You might aim to invest 30% in equity mutual funds and the rest in bond funds. Bond funds will produce a steady income through interest payments, while the limited stock component may allow you to see some investment growth.
Advantages and Disadvantages of Mutual Funds.
Like any source of investment, mutual funds come with several advantages as well as several disadvantages; let’s take them one by one:
Advantages of mutual funds:
Liquidity
Unless you opt for closed-end mutual funds, it is relatively easier to buy and exit a mutual fund scheme. You can sell your open-ended equity mutual fund units when the stock market is rising and make a profit. Track the exit load and expense ratio of the mutual fund.
Diversification
Equity mutual funds have their share of risks as their performance is based on stock market movements. Therefore, the fund manager distributes your investment in shares of companies in various industries and sectors called diversification. That way, when one asset class underperforms, the other sectors can compensate to avoid losses for investors.
Expert management
A mutual fund is good for investors who don’t have the time or skills to do research and asset allocation. A fund manager handles everything and makes decisions about what to do with your investment. The fund manager and research team decide on suitable securities such as equity, debt or a combination of both, based on the fund’s investment objectives. Moreover, the fund manager also decides how long to hold the securities.
Disadvantages of mutual funds:
Mutual fund management costs
The salary of the market analysts and the fund manager comes from the investors along with the operational costs of the fund. Total fund management charges are one of the first parameters to consider when choosing a mutual fund. Higher management fees do not guarantee better fund performance.
Redemption fees
It discourages investors from redeeming investments for some time. It also helps the fund manager to obtain the necessary funds to acquire the right securities at the right price and time.
Dilution
While diversification averages out your risks of loss, it can also dilute your profits. Hence, you should not invest in many mutual funds simultaneously. As you have just read above, the benefits of mutual funds can undoubtedly outweigh the disadvantages if you make informed choices.
We know it was a long article, but we wanted to give you a complete perspective on how to approach mutual fund investing. Why take this step? When? How do you set your goals and what will you need to consider? We hope we have answered all these questions. If you’d like us to develop topics on topics that interest you in particular, leave us a comment and we’ll get to work!
