In this video we will talk about Mutual Funds, what they are, their types, benefits and risks, key factors to focus on, and how to invest in them. Mutual funds are investment strategies that allow you to pool your money together with other investors to purchase a collection of Stocks, Bonds, or other securities that might be difficult to recreate on your own.
So what are mutual Funds and how do they work?
Mutual funds are investment strategies that allow you to pool your money together with other investors to purchase a collection of stocks, bonds, or other securities that might be difficult to recreate on your own. This is often referred to as a portfolio.
Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. To note here that the fund manager responsible for the fund, sometimes called its investment adviser, are legally obligated to work in the best interest of mutual fund shareholders.
A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.
Mutual funds give investors access to professionally managed portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund.
The funds invest in a vast number of securities, and performance is usually tracked as the change in the total market cap of the fund. Most mutual funds are part of larger investment companies such as Fidelity Investments, Vanguard, and Oppenheimer.
Now that you are aware of what a mutual fund is, it is time we talk about how they receive their market value.
The value of the mutual fund depends on the performance of the securities in which it invests. When buying a unit or share of a mutual fund, an investor is buying the performance of its portfolio or, more precisely, a part of the portfolio’s value.
Keep in mind that Investing in a share of a mutual fund is different from investing in shares of stock. Unlike stock, mutual fund shares do not give their holders any voting rights.
A share of a mutual fund represents investments in many different stocks or other securities. The price of a mutual fund share is referred to as the net asset value (NAV) per share, sometimes expressed as NAVPS. A fund’s NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding. Outstanding shares are those held by all shareholders, institutional investors, and company officers or insiders.
Mutual fund shares can typically be purchased or redeemed at the fund’s current NAV, which doesn’t fluctuate during market hours, but is settled at the end of each trading day. The price of a mutual fund is also updated when the NAVPS is settled.
So, why do people buy Mutual Funds?
Well, they have few perks that make them appealing to them. Those are:
Advanced Portfolio Management
When you buy a mutual fund, you pay a management fee as part of your expense ratio, which is used to hire a professional portfolio manager who buys and sells stocks, bonds, and so on. For many this is considered a relatively small price to pay for getting professional help in the management of an investment portfolio. This could be a good perk for new investors that don’t understand how the market works or how to invest themselves.
As dividends and other interest income sources are declared for the fund, they can be used to purchase additional shares in the mutual fund, therefore helping your investment grow.
Reduced portfolio risk is achieved through the use of diversification, as most mutual funds will invest in anywhere from 50 to 200 different securities—depending on the focus. Numerous stock index mutual funds own 1,000 or more individual stock positions. This allows investors to be well diversified in different stocks and sectors.
Convenience and Fair Pricing
Mutual funds are easy to buy and easy to understand. They typically have low minimum investments and they are traded only once per day at the closing net asset value (NAV). This eliminates price fluctuation throughout the day and various arbitrage opportunities that day traders practice.
Like all other investments we have reviewed in this channel , Mutual funds have their own disadvantages or risks, call it what you like. Those are:
One issue many holders of mutual funds face today is high fees. While mutual funds do quite a bit to help their investors, fees can be excessive in some cases. Some mutual funds have expense ratios of 1 percent or more, we will talk about expense ratios later on this video and explain what they mean.
Anyhow 1% may not sound like a large percentage, but it can cost some investors tens or even hundreds of thousands of dollars in their lifetimes. On top of that, the broker may charge you to buy or sell the fund, and some fund companies even hit you with a commission that could be 1 or 2 percent of the total investment, or what’s called a sales load.
Luckily, there are many index funds available with very low fees or no fees at all, allowing investors to build portfolios with a few funds for a very low cost.
Investors don’t have to worry about buying and selling securities all the time when they invest in mutual funds. That usually means a lot less work is needed from the average investor. But when a mutual fund sells securities from its portfolio, it may lead to year-end distributions to investors.
These distributions are taxable investment income.
They are taxed at either ordinary income rates or capital gains rates, depending on how long the fund held an investment, which means you might be left with a higher-than-expected tax bill at the end of the year. Those in high tax states may want to pay special attention to this issue, since it can eat away at your gains.
No intraday trading
Unlike stocks and ETFs, mutual funds are only traded once per day. That happens after the market closes at 4 p.m. Eastern time. While this is not a huge problem for passive investors, it could mean there is a different order price than you expect if you place orders manually.
An additional disadvantage for me and many others is that you have no control over the fund, so if you are that type of a person, mutual funds may not be for you.
There are different types of Mutual funds you can invest in. Most mutual funds fall into one of four main categories – money market funds, bond funds, stock funds, and target date funds. Each type has different features, risks, and rewards.
Lets have a look at them
- The Money market funds have relatively low risks. By law, they can invest only in certain high-quality, short-term investments issued by U.S. corporations, and federal, state and local governments.
- The Bond funds have higher risks than money market funds because they typically aim to produce higher returns. Because there are many different types of bonds, the risks and rewards of bond funds can vary dramatically.
- The Stock funds invest in corporate stocks. Keep in mind that Not all stock funds are the same. Some examples are:
Growth funds, which focus on stocks that may not pay a regular dividend but have potential for above-average financial gains.
- Income funds invest in stocks that pay regular dividends.
- Index funds track a particular market index such as the Standard & Poor’s 500 Index.
- Sector funds specialize in a particular industry segment.
The list can go on and on.
Last, Target date funds which hold a mix of stocks, bonds, and other investments. Over time, the mix gradually shifts according to the fund’s strategy. Target date funds, sometimes known as lifecycle funds, are designed for individuals with particular retirement dates in mind.
Mutual funds are an option for many investors, very popular among the younger generation believe it or not, as well as with employers and employees, as many 401K programs are heavily invested in mutual funds.
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