A mutual fund is a form of financial instrument that involves a pool of money collected from several investors to invest in several securities – bonds, stock, and other assets.
The funds are managed by professional money managers who allocate the assets invested and try to maximize gains and incomes for investors. The portfolio of a mutual fund is also maintained and built to match the objectives of the investors.
The significant benefit of mutual funds is that they give small or individual investors a lot of access to professional stock portfolios – pretty much any security can be invested in through a mutual fund. Thus, each shareholder participates proportionally in the gains and losses that the fund makes eventually.
These funds invest in several securities, and performance is also usually tracked as the change in the market capitalization of the fund.
Understanding mutual funds
Mutual funds get money from the public and use the money to purchase securities – usually bonds and stocks. The value of the company will depend on the performance of the securities that it purchases. So, when you buy a unit of a mutual fund, you’re also buying into the portfolio’s performance and a part of its value.
Investing in a mutual fund is also a tad different from investing in stock shares. Unlike stocks, mutual fund shares don’t provide any voting rights to the users. Instead, a share in a mutual fund simply represents investments in several stocks.
The average mutual fund holds hundreds of securities, meaning that mutual fund shareholders get important diversification at a low price. Think of an investor who purchases shares of a company before the company has a bad quarter. He could lose a significant amount of money because his cash is tied to the firm.
On the other hand, an investor could buy shares of a mutual fund that owns some of a company’s stock. When the firm has a bad quarter, the investor loses less because that company is just a small part of the mutual fund’s portfolio.
Investors in mutual funds usually earn their returns through any of the following:
- Dividends on stocks and interests on bonds that are held in the fund’s portfolio. The fund pays out almost all of the income it receives over the year to the fund owners through a distribution. Investors usually have the choice to either receive a check for their distributions o to reinvest their earnings for more shares.
- If the fund sells any securities whose prices have increased, it makes a capital gain. Most funds will pass these gains to their investors via a distribution
- If the fund’s holdings see a price increase but aren’t sold by the fund manager, the share of the fund rises in price. An investor could easily sell their mutual fund shares for a profit in the open market.
If a mutual fund is constructed as a virtual company, then its CEO is the fund manager the fund manager is usually hired by a board of directors and is obligated to work in the best interest of the shareholders. A lot of fund managers also own their funds, although there are some additional employees in the company as well.