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Investing 101

Investing in Mutual Funds

August 29, 2019


As unpredictable events are inevitable in life, people tend to look for permanent solutions to handle unforeseen and impending problems. Investing in different types of funds is one way to assure that you can face the challenges life throws at you.

You might have seen many people investing in mutual funds to float through the hard times. The passive investment is considered the best financial vehicle to make your future secure by investing in different bonds and stocks. Many finance experts believe that mutual funds are some of the best ways to begin investing.

But investing in something you do not have complete knowledge of is not a wise act. That is to say, understanding any investment vehicle is of paramount importance before you risk your money.

Let’s delve into the detail what mutual funds are, what types they have, and what benefits and risks do they entail to help you make an informed decision.

What are Mutual Funds?

Mutual funds are the investment portfolios that money managers operate. They allow an investor to pool his/her money together and invest in something. The money in this financial vehicle is collected from different investors such as money market, stocks, bonds, and various other assets for investment. Money managers allocate the assets of funds to produce income and capital gains for the investor’s funds. Managers also structure and maintain a mutual fund portfolio to match the objective of the fund’s investment.

Mutual funds give an individual investor access to portfolios of bonds, securities, and equities. All these portfolios are professionally managed. Therefore, each shareholder can participate in the mutual gains and losses of the funds proportionally. The investment in mutual funds is made in plenty of securities. The money manager tracks the performance when there is a change in the fund’s total market cap.

Types of Mutual Funds

There are many categories when it comes to dividing mutual funds. Each fund represents a different kind of security to target for its portfolio and the return it seeks. This might sound bizarre to you, but you can get the fund for every type of investment approach.

Some of the types of mutual funds are;

Equity Funds

This is one of the largest categories of stocks or equity funds.  As name shows, the type of funds is principally invested in stocks. Equity funds include various subcategories that are named on the company size they tend to invest in such as large-cap, small or mid.  

 Other equity funds are based on their investment approach e.g. income-oriented, aggressive growth, and value.

Fixed- income Funds

Fixed-income funds make another important category in which mutual funds focus on the investments that have set-rate of return. This may include corporate bonds, debt instruments, and government bonds. The fund portfolio in this investment vehicle generates fixed interest income to be passed to shareholders.

Index Funds

Index funds have gained popularity over the past few years. The investment idea is basically based on the approach that beating the stock market consistently is hard, so buying the major market index will prevent eat-up returns. So, the investment strategy is to purchase stocks with a high market index such as the Dow Jones Industries Average (DIJA). The funds work best for cost-sensitive investors.

Income Funds

Income funds have the purpose of producing income consistently. The investors of these funds primarily invest in the high-quality corporate debts that hold the bonds until their maturity to provide steady interest streams. The primary objective of income funds is to maintain and provide cash flow to their investors no matter how much holdings increase in value. Conservative retirees and investors are the main audiences of income funds as they produce income regularly.

Pros & Cons of Investing in Mutual Funds

Although mutual funds entail less risk as compared to individual securities as they include in the diversified investments, they may have disadvantages. Weighing their benefits and risks is essential to see whether or not it is the right investment for you.

 Benefits of Mutual Funds

Mutual funds offer a potential diversification, along with investment management.  Investing in them, you can earn money in three ways:

  • Increased NAV:   it depends on the market value of the mutual funds. If it increases after expenses are deducted, the value of your mutual funds and shares will also increase. The high NAV shows a high value of your mutual funds investment.
  • Dividend Payments: Mutual funds can earn money from dividend payments on bonds, interests, and stocks. The shareholders are paid all the money.
  • Capital Gain:  it is based on the security price in the mutual funds. When security with a high price on a fund is sold, it earns a capital gain.  These capital gains are distributed among the shareholders after subtracting any capital losses.

Risks of Mutual Funds

All types of Mutual funds may carry some risks.  For example;

  • When the value of the securities that your mutual funds hold goes down, you may lose invested money.
  • Interest payments and dividends can get change if the market condition changes.
  • If the funds have been volatile in the past, it may have a higher risk of investment.

Investment in Mutual Funds – FAQs

  • How can I invest in mutual funds?

Investing in mutual funds is easy. You can invest through an online stockbroker, or directly with any mutual fund company.

  • How can I choose mutual funds that are right for me?

Mutual funds come with different objectives. It is important to research the aim, benefits, and risks of the mutual funds to find the one that suits your investment needs.

  • Is investing in mutual funds risky?

Mutual funds are comparatively less risky than other types of funds.  However, it still entails a risk of declining NAV or sales charges that are associated with your funds.

  • Can I buy mutual funds through an IRA account?

Yes, buying mutual funds through your IRA account is possible.

 Key Takeaway

Overall, mutual funds might seem scary, but they are undeniably one of the best financial vehicles.  They are easy-to-buy and can be one of the cheapest options for beginners.

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