What are the benefits of mutual funds? How much do they cost? Which funds
are right for you? What should you consider before investing?
These are just a few of the questions we’ll answer here.
Mutual funds are not bank deposits and are not guaranteed by any government agency. They involve risks, including the possible loss of some or all of your investment. Past performance is not a reliable indicator of future performance.
However, it can help you assess a fund’s volatility and how it performs in various market conditions.
WHY INVEST IN MUTUAL FUNDS?
As an example, more than 100 million Americans use mutual funds to invest in their long-term goals. Here are some of the benefits they offer:
When you invest in a mutual fund, your money is managed by full-time professionals. They research and select investments that are appropriate for the goals of each fund, and monitor the fund’s performance so they can change the portfolio when needed.
Buying shares in a mutual fund make it easy for you to spread your holdings over many different companies and industries.
This can help protect your assets against market volatility. However, diversification does not guarantee a profit or protect against a loss.
Mutual funds give you a wide variety of choices to help meet your financial goals. You can invest for different objectives, at different levels of risk and in different kinds of securities.
Mutual funds enable you to invest with a relatively small amount of money. Outside of a fund, it would generally require a much larger investment to build such a diversified portfolio.
You can generally sell your shares at any time and for any reason. However, there may be rare occasions when fund sales are restricted due to extreme market conditions.
Mutual funds give you the option of reinvesting your dividends and capital gains in new shares of the fund, without incurring a sales charge.
A mutual fund is a collective pool of money provided by individuals for money managers to invest in various securities. It can be stocks and bonds, for example. Because it’s collective, every shareholder or investor benefits and loses an equal portion.
The expenses of the mutual fund are shared in the expense ratio. And, because the funds are diversified between stocks, bonds, and other securities, they are usually lower risk than individual stocks or bonds.
To some investors, picking individual securities to invest in and manage can be risky.
Enter mutual funds. With pros like additional security and lower risk, mutual funds are one of the hottest investment options out there. But before you jump into the collective pool, you need to know the cons.
Mutual funds are under the control of money managers.
They create portfolios for investment with a pool of money. Often, they have different kinds of investment goals. Some managers, like fixed-income managers, focus on generating low-risk, high pay-off investments for their funds, while long-term growth managers try to beat the Nasdaq or S&P 500 during the fiscal year.
Shares in a mutual fund are typically bought at the fund’s current net asset value (NAV, or sometimes NAVPS) per share. This figure is determined by dividing the total value of all the securities in the fund by the number of outstanding shares.
Mutual funds are actually investments like buying stock in companies.
Investors buy shares into the mutual fund, which in turn gives them a claim to the fund’s assets. So, the value of the mutual fund is contingent on the value of its portfolio.
When you invest in a mutual fund, a manager takes the public funds contributed to the fund pool. And invests them in various securities, such as stocks and bonds.
The manager is typically hired by a board of directors and is often a part-owner in the fund itself.
Fund managers will occasionally hire analysts to help them make investment decisions. Most funds will have an accountant who calculates the net asset value of the fund each day. That will determine the share price of the fund.
Most funds also have compliance officers who keep up-to-date on regulations.
Once investors buy into a mutual fund, their money is used by the fund manager to invest in various securities with certain goals for risk and return in mind: like long-term growth or fixed-income.
Some funds may be riskier than others, but in general, the structure of a mutual fund keeps risks relatively low.
Mutual funds only trade once daily and are often part of a 401(k) or an individual retirement account, IRA.
The biggest pro of mutual funds is, they are managed by someone other than the individual investor. You just have to put the tough decisions in a professional’s hands. The fund manager is able to devote much more time and expertise into wisely allocating your funds than you could yourself.
Additionally, because mutual funds often offer diverse portfolios with a collective pool of money, the individual risk to each investor is reduced. So we can say that mutual funds are fairly low-risk and high-reward.
However, mutual funds also come with fees in the form of annual operating fees and shareholder fees. Annual operating fees generally are 1%-3% of the annual funds under management, while shareholder fees are like commissions paid by shareholders when they buy or sell funds.
Besides that, an obvious con to mutual funds is that you don’t always have control over which stocks you’re investing in. Hence, for the savvy or active trader, this may cause some frustration, especially if your fund starts losing.
So, let’s see how to invest in a mutual fund.
Typically, funds are either equity funds (investment in stocks), fixed income funds (investment in bonds), or money markets (kind of like cash).
You will have to consider what is the minimum threshold for investing in the mutual fund. Because different funds have different investment minimums.
To invest, you can buy into a mutual fund through a mutual fund company, bank, or brokerage firm (similar to stocks). Also, you will have to decide if you want to invest in a load or no-load fund. This means you will either be paying commission or not. But regardless of if you invest in a load or no-load fund, you’ll still be paying some fees. So, you have to factor that in when deciding.
And, it is really simple to invest in a mutual fund. You simply determine the amount of money you’d like to invest over the phone, online, or in person. There are so many options today.
Online brokers generally often offer more diverse selections. However, you will have to open an individual retirement account.
There are several expenses to account for. Like, transaction fees accumulated when investing in a mutual fund, early redemption fees if you wish to sell a fund in the first 60 to 90 days, and expense ratios that are a percentage of your investment.
You can make money off of your mutual fund by selling it for more than you paid for it. Or through a variety of distributions like dividends or interest that can be paid out throughout your investment. However, most mutual funds will reinvest dividends for you unless you specify otherwise.
Can money invested in mutual funds be lost?
We will try to keep it simple. If you have invested in equity only mutual funds or a fund that has a good proportion in equity, theoretically – the money can be lost.
Practically – it depends.
The reason being, equity investments are time-sensitive. So, at a point in time, your portfolio can be in loss, which means your 100, for example, can be 95, 90, or 80.
But over the long period, the chances of losing your capital are close to zero.
Still, there might be chances of some major shock event that could demolish your accumulated corpus significantly. But, in most cases, it is temporary.
Let us explain.
During the 2008 financial crisis, the collapse in stock prices led to near 50% deterioration in the accumulated portfolio value of many people almost everywhere in the world. Many people might have panicked as this was a big story. However, within a year, the portfolio value bounced back to its 100% and if someone was actually holding till date, it would be further up 50–60% at least. In short, chances of losing in the long-term are very less.
Take a look at this chart:
Let’s do some math.
You invested $100 and holding it for 10 years earning 15% CAGR = $404.5.
You remember from the previous lessons: CAGR is the compound annual growth rate (CAGR).
Now a shock event in the eleventh year reduced by half = $202. This is still a return of 7.3%.
The risk, if you are compelled to sell here is not meeting your financial goals and considerably downgrading your lifestyle if you are retired. But if you see the history of the modern financial world, the value of financial assets have bounced back to normal from the worst of the depressions.
One last point is there is a lot of focus on the systematic investment plan (SIP). But there needs to be an equal focus on a systematic withdrawal plan (SWP). There you start taking out some money from risky assets as you near your goal and park in safer assets. So, the chances of not meeting your financial targets are minimized.
The note: Mutual fund investments are subject to market risk. This you must have in your mind always when investing in mutual fund schemes. There are no investments without some kind of risk attached to it.
Losing or gaining money depends entirely on the investment period an investor chooses.
We will show you how it looks in one more chart. We pointed out the period of big crisis 2008, in the red circle.
For example, you invest $1,000 for a day or two. If the stock market slips the preceding day, the value of your $1,000 will surely not appreciate.
Also, if you invest the same amount for a week and the market is in a downtrend throughout that week, the invested money will not yield any profit.
If you choose to stay invested for a year or more than that, though there is no guarantee, there is a possibility that your $1,000 may go up as a long-term investment horizon is always likely to give better results.
In other words, you won’t lose all your money. Money can be lost mostly due to the wrong timing. When the market is bullish, people invest aggressively. When the market corrects, people get scared and they take out money when the market is down or sideways.
Say, investing in stocks through mutual fund route is a safer way to putting in money in the ever-volatile stock market. In a mutual fund, your investments are managed by professionals, who ensure the protection of your capital.
Past trends have shown that usually mutual funds are profitable giving an average return of around 10-12%.
Mutual fund investments become even safer and convenient if done via the SIP (Systematic Investment Plan) route. SIP is a type of investment set up whereby rather than putting in a lump sum, you put in small amounts of money either in monthly, quarterly or annual installments. This, in turn, enables the fund to benefit from the power of compounding and also isn’t too much of a burden on the investor.
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What is the crucial rule of risk control?
Why do investment advisers recommend moving more assets to the “safer than stocks” class if you are near to the retirement period?
Because mutual funds are collective, every shareholder or investor benefits and lose in equal portion.