A mutual fund is a financial instrument created out of a sum of money taken from several investors. The money is then invested in securities in the financial markets. The mutual funds are handled by money managers. They allocate the mutual fund's assets and try to create income or capital gains for the mutual fund investors. A mutual fund portfolio is developed and maintained to match the aims of investment given in the prospectus. Mutual funds also give individual and retail investors access to a portfolio of securities such as bonds and equities that are professionally managed. All the shareholders participate proportionally in the losses or profits in the mutual fund. The performance of the mutual funds is seen as the change in the overall market cap of the fund. It is found by adding up the performance of the investments that are underlying the fund. Let us find out more about what is a mutual fund.
Some people may be confused about what is a mutual fund's nature. A mutual fund is an actual firm and an investment. This may seem peculiar to some. But it is quite similar to how a share of a firm is a representation of the firm itself. When any person purchases the stock of the firm, he is getting partial ownership of the firm and its assets. Any investor who invests in a mutual fund essentially purchases some ownership of the mutual fund firm and its assets. The major difference is that a normal firm might be involved in providing various goods and services to the general public. At the same time, a mutual fund firm is in the business of creating investments. There are several ways in which an investor can get a return from a mutual fund.
The first way to get income in the mutual fund is from dividends and interest on securities present in the mutual fund's portfolio. A mutual fund pays out most of the income it gets over the year to the fund owners as distribution. The funds often give the people a choice to reinvest the earnings and get more stocks or money through the distributions. The second way is if the mutual fund sells stocks that have grown in price. This creates a capital gain for the firm. Many funds give these profits to their investors through a distribution. If the mutual fund holdings grow in price but are not sold by the fund manager, the mutual fund's shares grow in price. The investor can then sell the mutual fund's shares to get an overall profit in the financial market. If the mutual fund is developed as a virtual firm, the CEO is seen as the manager of the funds. They are also called the investment adviser. The manager of the mutual fund is hired by a board of directors.
It is legally compulsory to function solely for mutual fund investors. Many managers of mutual funds are also the owners of the fund. There are not many employees in a mutual fund firm. The manager of the mutual fund or the investment adviser may get a few analysts to assist in choosing the investment or do some market research. There is also a fund accountant on staff to find out the daily value of the mutual fund portfolio. This value finds out if the share prices have gone down or up. Mutual funds also need to hire a few compliance officers and an attorney. They help to maintain all the regulations put in place by the Government. Many of the mutual funds are a part of a bigger investment firm. Most of the big firms have numerous mutual funds. Some of these mutual fund firms are known to the wider public.
A mutual fund will segregate the expenses into shareholder or annual operating fees. The annual fund fees are a yearly percentage of the general funds put under management. This keeps in the usual range of a couple of percentage points. The annual operating fees are known as the expense ratio. The expense ratio of a mutual fund is the total of the administrative costs and the management or advisory fees. The shareholder fees come in redemption fees, commissions, and sales charges. These are paid directly by the investors when selling or buying the funds. The commission or sales charges are called a Load of a mutual fund. When any fund has a load that is front-end, the fees are calculated when the shares are bought. For a load that is back-end, the fees of the mutual fund are calculated when the investors sell their shares. There are times when an investment firm also gives a mutual fund that has no load. This type of fund does not come with any sales charge or commission. These mutual funds are given directly by an investment firm rather than a secondary party.
Several mutual funds also levy penalties for the selling or withdrawals of the holding before the expiry of a certain period. The increasing usage of exchange-traded funds has led to lower fees because they are managed passively. This has led to stiff competition in the mutual fund industry to get the investors' money. There have been media articles about how the loads and the fund expense ratios can lower the rates of return for the investor. This has also led to many investors seeking other avenues to enter the financial markets instead of mutual funds.
There are many reasons why mutual funds have been the instrument of choice for retail and small investors for many decades. Most of the money in the retirement plans sponsored by employers goes into these mutual funds. Diversification is one of the major advantages one receives when investing in mutual funds. It is the mixing of assets and investments within a portfolio to decrease the overall risk. The experts of the financial markets always advise investors to follow diversification as a path to increasing the returns of a portfolio. It also helps to decrease the overall risk. Purchasing individual stocks of firms and offsetting them with stocks of different firms gives a level of diversification. But a completely diversified portfolio has shared various levels of capitalizations and bonds with varying issuers and maturities. Purchasing a mutual fund can lead to cheaper diversification and is simpler than purchasing individual shares.
The large mutual funds own numerous different stocks in various industries. It will not be very practical for any investor to develop this type of grouping with little money. The mutual funds also give economies of scale. Purchasing a mutual fund spares the investor from various commission charges levied when one tries to create a portfolio. Purchasing only single security at a time results in huge transaction fees. This can eat up a great chunk of the investments. Any mutual fund sells and purchases huge amounts of securities at a single time. So, the transaction costs are lower than what any person would pay for the transactions regarding these securities. Also, any mutual fund pools money from several individual investors; they can invest in some assets or ensure bigger positions than what a retail investor can afford.
So, what is a mutual fund's practical use for you? Investors have the choice to research and choose the fund managers of their liking according to their aims and management styles. There may be managers that manage funds that use many differing styles. The variety offered by mutual funds permits investors to get exposure to bonds, stocks, foreign assets, and commodities through specific mutual funds. Several mutual funds are created to profit from a decreasing market. The mutual funds give domestic and foreign investment chances that are usually unavailable to the retail investor.