Mutual funds basics

The term mutual funds is commonly used in the US to refer to a type of collective investment scheme where funds from different investors is pooled together and used to purchase investment securities, such as bonds, money market instruments and shares. The funds are managed by mutual funds managers who make investments with the fund’s capital on behalf of the investors to produce capital gains for the investors. Different types of mutual funds area available with both advantages and disadvantages to the investor compared to individual direct investments in securities.

Types of mutual funds

The three types of mutual funds available are unit investment trust, open-end mutual funds and closed-end mutual funds. The most popular type is the open-end mutual fund where the fund must buy its shares back from its investors at the end of each business day. Closed-end funds are issued to the public once through an initial public offering (IPO) while unit investment trusts are open-end funds that can also be traded in the stock market. Investors cannot, however, sell back their closed-end shares to the fund like in open-end funds. They can only sell their shares to another investors in the stock market.

Advantages of mutual funds

The main advantage of a mutual fund is that it gives small investors access to diversifies portfolios of bonds, equities and other securities that are managed by professionals, which would be quite difficult to create (if not impossible to create) with a small capital amount. As a mutual funds shareholder, you participate in the loss or gain of the fund proportionally, depending on the mutual fund units you hold. Mutual funds shareholders can also typically redeem or purchase mutual fund units as needed at the current net asset value (NAV) per fund unit or share. Other benefits of holding mutual funds include ease of comparison, convenience factor and government oversight.

Disadvantages of mutual funds

The main disadvantages of mutual funds include lack of the opportunity to customise, unpredictable income, sometimes high fees and less control over the timing of investment gains recognition.

Mutual funds securities

Mutual fund securities that a given fund may invest in are stipulated in a funds’ prospectus. The funds prospectus describes the investment approach, objective and permitted investments for the funds. The investment objective sets what the fund seeks to achieve. For instance, a capital appreciation mutual fund typically aims to earn most of its returns from price increases of its securities than from interest or dividend income. You are usually free to sell your mutual funds shares at any time, but you need to be aware that prices of the funds fluctuate daily, depending on the performance of the fund’s securities.

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