An exclusive guide to mutual funds
How do mutual funds work, exactly? It is fascinating how people pretend to know about this fairly esoteric finance topic but do not actually have any idea what they are. Through this expert guide, you will find out how mutual funds work and how you can leverage them to make more money.
Let us start by defining the term. Primarily, mutual funds are baskets with different types of investments, usually stocks, which allow people to invest while mitigating the risk of selecting individual securities. Put simply, mutual funds allow average investors to choose the types of funds that suit them as opposed to requiring investors to perform the Herculean task of picking individual stocks.
Types of mutual funds
There are different kinds of mutual funds and each has its benefits and drawbacks. One can choose a mutual fund based on a variety of different factors such as risk, return, sector and geographic area of investment among others. For instance, you can invest in a fund focused on energy services or even medical devices.
These funds tend to fall into the following categories:
Money market funds – high quality, short- term (less than one year) investments in securities issued by the government or corporations. The government issues U.S. Treasury securities like CDs while corporations issue commercial papers. They have the lowest risk and therefore the lowest returns.
Bond funds – these are also called fixed income funds. As the name implies, these funds invest and trade different kinds of bonds. They may be investments in the form of debt to an investor with a fixed interest rate. Typically, they have higher returns than money market funds. Consequently, they come with additional drawbacks because interest rate risks affect all bond funds. If rates go up, bond fund value drops and vice versa.
Equity funds – better known as stock funds, equity funds invest stocks comprised of various companies. They are divided into three different classes. These are large-cap for big blue-chip companies like Apple, mid-cap for companies that are not behemoths but are not startups either and small-cap for smaller companies.
Hybrid funds – a combination of stocks, bonds and other investments. Most of these funds invest in other mutual funds.
How mutual funds work
Mutual funds work by pooling money from various investors and investing it in a portfolio of other assets such as stocks and bonds. Using mutual funds generally imply that you are able to invest in portfolios that you would not, otherwise, be able to afford alone.
Mutual funds are extremely popular because they allow consumers to pick a fund that contains different stocks with mitigated risks. You do not have to worry about putting too many eggs in one basket with a mutual fund. This reduces the risks you are likely to encounter similar to if you bought individual stocks. Additionally, the funds provide instant diversification with the many different stocks.
Investing in a fund manager can be advantageous for beginner investors who do not have much experience and would rather place their faith in an expert in the mutual fund world. Note that anyone who tells you they are an expert and can out-play the market is lying. It is impossible to predict what will happen in the future.
Always try to engage an appropriate fund manager when contemplating mutual fund investments. They offer many incentives to do well, as their jobs literally depend on how the funds perform. After all, their bonuses, which can exceed the million-dollar mark, are contingent upon the performance of your stock.
How mutual funds pay
Mutual funds pay out in two major ways.
Distributions – if a mutual fund contains an asset that pays dividends, the fund manager should distribute the dividends to the fund owners. Alternatively, the distributions can also come in the form of interest and capital gains.
Capital gains – in this payout, you obtain money when you sell your mutual fund for more than the original price.
The dollar amount you earn depends on a variety of factors. Among the most essential factor is the competency of your mutual fund manager. Therefore, selecting an experienced fund manager is important.
Feel free to get in touch with us here at Mount Bonnell Advisors if you would like to get more information about mutual funds. It would really help to get more tips on how to invest in mutual funds both as an individual and as a company.
