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What is a mutual fund?

All about mutual funds

The mutual fund is one of the most popular ways of investing in the stock market. It is one of the best investment options for someone who wants to create wealth. It is a known fact that investing in the stock market can yield the highest returns. Buying stocks is risky and it is difficult for a layman to know which stocks will yield good returns and which won’t. Regular tracking of your stock investments is essential,as you never know when the company you have invested in may face problems. This can make you lose a lot of money.

Those who are worried about the risk involved in the stock market or don’t have the time to track the market regularly can opt for mutual funds. As the name suggests, a mutual fund is where many investors pool their money to create a fund for mutual benefit. This fund is then used to invest in the stock market, as well as other instruments like bonds and money market instruments. An established investment company runs the fund and it is managed by a professional fund manager.

The fund manager has expertise and experience in dealing with financial markets. He invests the fund to create a portfolio so that it yields handsome returns for investors. Depending on the objective of the fund, the portfolio would contain a mixture of stocks, bonds, and even cash. It is the fund manager’s responsibility to buy stocks, track its performance periodically, and make changes in the portfolio as required.

Benefits it offers

As the value of the portfolio goes up, so does the value of the investments by individuals. An individual investor benefits by investing in mutual funds in the following ways:

  • To buy shares in a top company, an investor may need a huge sum of money. Mutual fund investment can be done with even with $500. You are not buying stocks here; you are buying shares or units of the mutual fund and can thus invest a lower sum of money.
  • You need not worry about which stocks to buy, when to buy, and when to sell. A professional manager is on the job with the sole aim of ensuring appreciation in the fund value.
  • It is the fund manager’s responsibility to regularly monitor the stock market and performance of companies. Any changes to the portfolio arethe responsibility of the fund manager. As an investor, you can invest your money and relax.
  • Various types of mutual funds are available that cater to different needs of investors. You can invest in the fund type of your choice.
  • You can sell your shares in the mutual fund anytime. The value of the shares as on that day will be used to compute how much you have earned.

Types of mutual funds

As mentioned above, there are different types of mutual funds available. Depending on your investment goals and your tolerance to risk, you can invest in any of them. You can diversify your investments by investing a little money in 3 or 4 funds instead of putting all your money in one fund. This diversification helps you reduce your risk. The fund manager, in turn, buys different types of securities, diversifying further. This is how investing in mutual funds are less risky as compared to direct purchase of stocks.

Some of the popular mutual fund types are:

  • Growth funds are those whose objective is to make the investment value grow by investing in companies that are expected to grow.
  • Value funds are those that invest in value stocks that usually sell at a lesser price. The objective is to create value by investing in these funds.
  • Large cap funds are those that invest in big companies that have a large market capitalization.
  • Mid-cap funds invest in companies with a moderate market capitalization size. These are companies poised to take off.Investing in mid-cap funds can be risky, buy it can also yield the highest rewards.
  • Small-cap funds are small-sized companies. Their stocks are usually available at low rates and they can be a very good investment.
  • Bond funds are those that invest money only in bonds. It could be government bonds or bonds issued by companies. The returns would be less and so would the risk.
  • Sector funds invest money in buying stocks of a particular industry sector. An IT fund would buy stocks only of IT companies. This is a good investment when a particular sector is predicted to do well. It is risky as you can make losses if the industry sector under performs.
  • Index funds are very popular. They invest money in stocks that form the stock market index. For example, S&P 500 is a popular stock market index that contains 500 top stocks. An index fund could invest in the same stocks as the S&P 500. This ensures that the performance of the mutual fund mirrors that of the stock market index.
  • Hybrid funds are those that invest in both stocks and bonds in varying ratios. They help to balance risk and safety.

How it works

If you want to invest in a mutual fund, you can buy them directly from the investment company or by opening an account with a brokerage. Instead of investing a large sum at one go, you can consider systematic investment. Here, you decide the funds you want to invest and the amount to invest every month. You can give a standing instruction to your bank and every month the said amount will be debited to buy shares of mutual funds. You can thus invest systematically month after month.

This is a disciplined approach to investing.When the fund value is low, you can buy more shares in the fund. When the fund value is high, your overall value increases. Regular investments for a long period help you to earn more money, thanks to compounding. This is an ideal way to invest in mutual funds.

Mutual funds are a boon for small investors, who can invest small sums of money to create wealth.