Mutual Funds Investing Explained for Beginners
One of the most complex parts of investing is building a portfolio of stocks and bonds that you feel comfortable with. A mutual fund is a way to easily invest in ready-made portfolios.
Investing is an important part of saving for the future. While you can put your money into something like a savings account or certificate of deposit, investing your money in securities like stocks and bonds can provide higher returns in the long run.
What are mutual funds?
A mutual fund is a type of investment that you can use to buy shares in many different securities at once.
To start a mutual fund, a fund manager collects money from several investors interested in investing in the fund.
Each investor is given shares in the mutual fund based on the money he invests.
The manager uses the money collected from investors to buy various stocks and bonds.
The types of securities the manager purchases will depend on the mutual fund’s strategy (more on this later).
When an investor wants to invest more in the mutual fund, the manager takes his money and gives him more shares in the fund.
The manager then uses that money to buy more securities for the mutual fund’s portfolio.
When an investor wants to get his money back from a mutual fund.
He can sell his shares back to the fund. The manager sells securities from the fund’s portfolio when necessary to return the investor’s money.
How does a mutual fund work?
A mutual fund is an investment and an actual company. This dual nature may seem strange. But it’s no different from how Apple’s stake is represented. When an investor buys Apple stock, they are buying partial ownership of the company and its assets.
Similarly, a mutual fund investor buys partial ownership of the mutual fund company and its assets. The difference is that Apple is in the business of manufacturing innovative tablets, while the mutual fund company is in the investment business.
How do you benefit from a mutual fund?
- Income is earned from dividends on shares and interest on bonds in the fund’s portfolio.
- The fund pays almost all income received during the year to the owners of funds in the form of distribution.
- Funds often give investors a choice to either receive checks for dividends or reinvest dividends and get more shares.
- If the fund sells securities whose price has gone up, the fund receives a capital gain. Most funds pass these gains on to investors in the distribution process.
- If the fund’s holdings increase in price but are not sold by the fund manager, the cost of the fund’s shares increases.
- You can then sell your mutual fund shares to make a profit in the market.
What are the types of mutual funds?
In the following lines, we mention the types of mutual funds:
Focus on stocks
A common strategy is to build a mutual fund that focuses on buying shares in different companies. Fund managers can choose companies to invest in using several other criteria.
One common criterion is the company’s market value or total value. Large corporations—those that are worth $10 billion or more—are called large corporations.
Small businesses under $2 billion are small businesses.
Those with a market capitalization between $2 billion and $10 billion are mid-cap.
Small companies tend to be investments with higher risks and higher rewards, while larger capitals are more stable but offer lower potential returns.
Fund managers can also use other strategies. Such as focusing on stocks from companies that pay dividends or selecting stocks that are part of a particular index.
Focus on the bonds
Bond-focused funds invest in different types of bonds. As mutual funds that focus on stocks, fund managers can use different strategies when building their portfolios.
For example, a manager might build a fund that contains only high-quality government debt. Another might focus on municipal bonds — a third buy low-grade corporate bonds with higher risks but higher returns.
Investing in a bond fund allows investors to obtain some collateral for the bond while reducing the risk of default. They may face if they hold bonds from only one issuer or a few issuers.
balanced fund strategy
Balanced mutual funds own a mixture of stocks and bonds. Most of them aim to give investors a pre-made portfolio to meet all their investment needs.
For example, a balanced fund may have 70% of its portfolio in stocks and 30% of its portfolio in bonds.
This is a common strategy for investors. Stocks tend to offer higher returns but with more volatility. Bonds are less volatile but generally have lower yields. Combining the two allows investors to get some of the highest stock returns while using adhesives to reduce volatility.
money market financing
Equity funds are a special type of mutual fund that holds high-quality, short-term debt from corporations and governments. This money works similarly to a savings account or checking account. However, it does not have the same level of insurance and security.
However, it is low risk, to the point that many brokerages will hold investors’ uninvested money in a money market fund until the client decides to withdraw the funds or submit an application to invest it.
Mutual Fund Advantages
There are many advantages enjoyed by the mutual fund, which are as follows:
To build a diversified portfolio without mutual funds, you will need to purchase dozens of different stocks and bonds.
With a single mutual fund, you can diversify your investments among hundreds of different securities.
You don’t have to worry about rebalancing your investment portfolio or buying stocks on time. The fund management team handles these details for you.
You can buy and sell shares in mutual funds easily if you need to access your money quickly, making it a liquid investment.