Basic Information for Investment in Mutual Funds.
What is A Mutual Fund ?
A Mutual fund is a company which raises money from investors then invests the money in some instruments like stocks, bonds, and money markets which is managed by professional Investment managers.
Some Terms Used In Mutual Funds :
1. NAV (Net Asset Value) : This is a value which indicates the performance of your Mutual Funds. You can calculate NAV of your shares from :
(Price of Mutual Fund x Shares of Mutual Funds you have) - Administrative/trading Fee.
2. Share : Share is a unit of Mutual Fund you have.
Shares you get is calculated from = (Money you pay - Buying Fee) : Price.
3. Redemption : The process when you redeem/sell your shares.
Money you get when you redeem your Shares = (Number of Shares you sell x Price) - Selling Fee.
4. Price : You can check the price of your mutual funds by looking it up on economic newspaper or ask the Securities company from which you bought mutual funds.
5. Portfolio : Combined stocks, bonds, and other assets which are owned by a Mutual Fund.
Benefits Of Investing in Mutual Funds:
1. Managed by Professional Fund Managers:
Investment is taken care by Investment Managers who have expertise in fund management. Their role is very important since they carry out mandates from investors who don't have information/knowledge and time in executing their investments.
2. Diversified Investment.
The portfolio of investment is diversified in several kinds of stocks or securities in order to minimize risks; therefore, investing in mutual funds will not be as risky as investing in individual stock.
3. Transparent .
The Investment Managers are obliged to :
3.1 Disclose information about performance of their Mutual Funds and all deductible fees so that investors are well informed about profit/loss, deductible fees, and investment risks.
3.2 Announce NAV on newspaper every day, and publish first half and annual financial statements, distributes prospectuses so that all investors can monitor performance of their investments.
4. L i q u i d.
Portfolios of mutual funds are selectively chosen with high liquidity. Being very liquid it enables investors to redeem their shares anytime agreed by investors and by the investment manager. An investment manager is obliged to buy back an open end Mutual Fund shares of which also guarantees liquidity.
5. Low Cost.
Since a Mutual Fund is a collection of investors' funds which are managed professionally, this brings result in low operation cost and efficient transaction fees.
Types of Mutual Funds
Basically Mutual Funds fall into 4 categories. Each type has different features, different risks, and different rewards. The principle that investors should keep in mind is "The higher the potential rewards the higher the risks" :
1. Fixed Income/Bond Mutual Funds :
Mutual Funds which invest at least 80% of its money in debt instruments, including bonds. The risk of fixed income funds is generally higher than money market funds but lower than stock funds.
2. Stock/Equity Mutual Funds :
Funds which invest in stocks at least 80% of their money. They give the highest returns but also have biggest risk.
3. Combined or Mixed Mutual Funds :
These are Funds which portfolios consist of combination of bonds and stocks.
4. Money Market Mutual Funds :
Mutual Funds which their investments are on debt securities that mature below one year. This fund has the lowest risk; hence, the lowest returns too.
How Mutual Funds get profits (or loss).
Capital/fund growth is earned by a Mutual Fund from 4 sources :
Dividends and bonuses given by stocks in their portfolio
Money markets interests.
Capital Gains from stocks and bonds trading, and from cashing deposits and other portfolios.
Risks of Investment in Mutual Funds
Investors should know kinds of risks when they invest in Mutual Funds :
1. (Up and) Down of NAV :
Fluctuation of NAV is caused by market dynamics which influence the portfolios constituting the Mutual Funds. News like the country's ailing political or economic condition, soaring performance of companies are some factors that can create the market dynamics.
2. Risk of Liquidity :
A Mutual Fund may become not liquid if a lot of investors redeem their shares all at one time or day, or when there is a big rush for redemption of the shares. This situation might be triggered by a very bad sentiment or news which scares the market, like political and economy collapses of a country, the shutdown or bankruptcy of some companies, etc.
3. Market Risk :
Market risk is the result of soaring stocks, bonds, and money markets. This bearish situation happens when many securities (stocks and bonds) suffer from deep price corrections, which will also influence a Mutual Fund's NAV. Hence, the trends of securities markets should be taken into investors' consideration before deciding on which type of mutual fund their money will be invested.
4. Default Risk :
Default risk occurs when the bonds which constitute the Mutual Fund's portfolios fail to repay principals on their maturity dates. That's why prudent strategy in choosing bonds should be applied by all Investment Managers in order to avoid default risk.
Things to Consider Before Picking up A Fund.
Before investing in Mutual Fund you need to figure out your financial goal and risk tolerance.
If you belong to a risk seeker that high returns and investment growth are your targets, stock fund is your choice.
If your investment goal is for pension saving and constant low to moderate earnings is satisfactory, then bond funds or money market funds may suit you.
Another wisdom in minimizing risk is "Don't put your eggs in one basket" meaning that you shouldn't pool your money in one kind of investment only. Putting money in combined portfolios which contain stocks, bonds, money market, and mixed funds is better decision than if we stick to only one kind of fund.