Financial Tips: What Is A Mutual Fund?

Investing in mutual funds is always a safer bet and a prudent decision when you are new to the stock market. This is because mutual funds are professionally managed and the chances of loss are minimal as the investment is diversified.

In layman's terms a mutual fund is an investment company that pools money of many investors and invests it in a variety of securities, including bonds, stocks and short term money market instruments. Shares of the fund are offered, and can be sold back to the fund at anytime at that day's share price. This fund is managed by a professional who uses the pooled money to buy these securities and monitors each of these investments on an ongoing basis. Since, the fund uses cash from the pool of savers to buy a wide range of securities like stocks, bonds and real estate; it leads to a diversification of investments of each investor. This is because each investor owns small units of each of the funds investments. Thus, professional management and diversification are the two most important benefits of mutual fund investing.

There are two types of funds, either open-ended or closed ended. As open-ended investments, most mutual funds continuously offer new shares to investors. The price of the shares is determined by dividing the total net assets of the fund by total number of shares outstanding. Closed-end funds issue a fixed number of shares in an initial public offering. In both the cases, they charge a management fees for these services which is typically 1% or 2% an year. Apart from that, funds also levy other fees and take sales commission, known as load, if purchased from a financial advisor. Though mutual funds offer individual diversification and professional management, but they limit investor's ability to control the holdings and tax liability. Apart from that fund owners also pay an expense ratio, which is a percentage of their total investment amount.

Mutual fund Companies are generally registered with the SEC under the Investment Companies Act of 1940. All funds are also supposed to issue prospectus which is a document clearly stating its strategy or "investment style." Mutual funds with open ended investments issue redeemable shares and are distinguishable from closed-end funds whose shares are tradable in the secondary market. There are a variety of goals offered by the mutual funds to the investors, depending on the fund and its investment charter. For example, some funds generate income for the investor on a regular basis, while others seek to preserve the investor's money. There are other funds too which invest in companies that are growing at a rapid pace.



There are various categories of mutual funds, including but not limited to money market funds, equity funds and index funds. A money market fund is the one which invests in short- term and stable securities. These funds are easily convertible into cash and usually maintain an unchanged value of $1 share. However, money market funds aren't insured by the federal government. An equity fund on the other hand is the one where the investor possesses an ownership in various corporations/ companies by way of holding shares in these corporations.

Index funds are a class apart. In this type, funds are invested in stocks and bonds that constitute an index. This is done in such a way that the fund matches the performance of the index. Here, index means grouping of stocks to represent a certain market segment. Index funds have other advantages too, such as tax efficiency and low expenses. The Vanguard group is a very good example of an index mutual fund company. Vanguard is known for its index funds. It avoids making bets on interest rates and steers clear of narrow stock groups. Fund managers keep the trading levels low, which holds the expenses down; in addition the company discourages customers from rapid buying and selling, because doing so drives up the cost and requires a fund manager to trade in order to deploy new capital and raise cash for redemptions.

To conclude, whatever be the type of fund, investing in mutual funds is always a safer bet and a prudent decision when you are new to the stock market. This is because mutual funds are professionally managed and the chances of loss are minimal as the investment is diversified.

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