Mutual Funds

Mutual Funds

A mutual fund is a type of financial vehicle that consists of a pool of money that many investors have collected to invest in securities such as stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the assets of the fund and try to generate capital gains or income for investors of the fund.

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The portfolio of a mutual fund is structured and maintained in line with the investment targets set out in its prospectus.

Mutual funds provide access to professionally managed portfolios of equities, bonds, and other securities for small or individual investors. Consequently, each shareholder participates proportionally in the fund’s gains or losses.

Mutual funds invest in a large number of securities, and performance is generally tracked as the change in the fund’s total market cap — derived from the aggregate performance of the underlying investments.

How Do Mutual Funds Work?

As you may have learned, a mutual fund scheme pools money from multiple investors and invests the collected corpus in listed companies' shares, government bonds, corporate bonds, short-term money-market instruments, other securities or assets, or a combination of those investments.

Instead of requiring investors to perform the challenging task of collecting individual stocks themselves, mutual funds allow average investors to simply select the types of funds that would suit them.

Mutual funds are extremely popular because they allow you to pick one fund which contains different stocks and do not worry about putting too many eggs in one basket.

The funds provide immediate diversification as they hold a lot of different stocks. The first thing most people encounter with mutual funds is through their 401k, where they choose from a range of options.

Mutual funds are typically managed by a fund manager, who selects all the portfolio investments.

This is often a great selling point for beginner investors who have little experience and would rather put their faith in an "expert" in the world of mutual funds.

How Mutual Funds Pay

Mutual funds pay out two different ways:

1. Distributions

If a mutual fund contains an asset that pays dividends (i.e., money a company pays out to shareholders), the fund manager must distribute the dividends to the fund owners. The distributions can also come in the form of interest and capital gains.

2. Capital Gains

You accrue capital gains money when you sell your mutual fund for more than you initially paid for it.

The amount of money you earn from each depends upon a variety of factors. Your mutual fund manager is one of the most important factors.

Types of Mutual Funds

Mutual funds are divided into several categories, representing the types of securities they've targeted for their portfolios and the type of returns they’re seeking.

There's a fund for almost every type of investor or approach to investment.

Certain common types of mutual funds include money market funds, sector funds, alternative funds, smart-beta funds, target-date funds, and even fund-of-funds or mutual funds that purchase shares from other mutual funds.

1. Equity Funds

The biggest category is that of stock or equity funds. As the name suggests, this kind of fund invests primarily in stocks.

There are diverse subcategories within this group. Some equity funds are named for the size of the companies that they invest in: small, medium, or large-cap companies. Others are named by their approach to investment: aggressive growth, revenue-oriented, value, and others.

Equity funds are also categorized according to whether they invest in domestic (U.S.) or foreign equity stocks.

2. Fixed-Income Funds

Another type is the category of fixed income. A fixed-income mutual fund focuses on investments, such as government bonds, corporate bonds, or other debt instruments, that pay a set rate of return.

The concept is to generate interest income from the fund portfolio, which it then passes on to the shareholders.

These funds, sometimes referred to as bond funds, are often actively managed and seek to buy relatively undervalued bonds to sell them at a profit.

3. Balanced Funds

Balanced funds invest in an asset class hybrid, be it stocks, bonds, money market tools, or alternative investments. The goal is to cut the risk of exposure across asset classes.

This type of fund is also called an asset allocation fund.

There are two variations of those funds designed to meet the objectives of the investors.

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