A Mutual Fund is a Trust or Company that pools money from many investors and invests in a specified class of securities such as stocks, bonds, real estate or a balanced mix of asset classes. The Mutual Fund is managed by a professional management company who formulates and implements investment management services to the Mutual Fund on behalf of the investors.
The Advantages of Buying Mutual Funds
Diversification: Buying one unit of a Mutual Fund allows investors the opportunity to diversify their scarce investment capital into all the assets held by the Mutual Fund. By so doing, all their eggs are not in one basket.
Professional Fund Manager: The Mutual Fund investors outsource the day to day operations and management of the fund to professional money managers. This frees up the investors’ time and allow best practice to come to bear on the Mutual Fund Assets
Cost Effective: Mutual Funds offer a low cost way of investing in the overall market ad economy. Owning a unit of an Index Fund, for instance, means the investor has a piece of all stocks listed in that stock exchange. The same example, buying a Real Estate Trust (REIT) allows the investor “own” a share of many properties.
How do Mutual Funds Work?
A Mutual Fund is created by a fund manager. The Fund manager specifies what kind of investment strategy the Mutual fund will pursue (e.g. buying and holding fixed income securities for dividends or Active stock trading.) The Fund manager then offers the Mutual Fund to investors to subscribe to by buying units of the Mutual Fund. The fund investors buy directly from managers. The Mutual Fund can either be set up as a closed end or an open end fund.
A closed end Mutual Fund will issue a determined number of shares of the fund at inception and will not issue any more shares going forward. Future price movements of the Mutual Fund become based on demand and supply of the shares of the Mutual Fund. An open ended Mutual Fund, on the other hand, will create and destroy shares as new investors buy new shares or sell the Mutual Fund shares respectively.
The Mutual Fund then takes these investors’ pools of funds and invests in securities as matching the stated investment objective. The fund manager builds a portfolio of assets using funds from the shares of the fund bought by the investors.
Based on the type of Mutual Fund, the investors can either get cash dividends or see the value of their shares rise. An Equity Growth Fund like the ARM Aggressive Growth Fund, for instance, will invest in shares of promising companies who have very rapid growth and reinvest their profits or cash back to fund internal growth. These type of fund will satisfy an investor seeking a Capital Appreciation objective
On the other hand, a Money market fund like the Afriinvest Plutus Fund will invest in short-term, fixed income securities. These type of funds will generate a lot of cash dividend and will satisfy an investor seeking dividend or Capital Preservation Objective.
What Types Of Mutual Funds Are There?
Mutual Funds are created and characterised according to their investment objective. Mutual Funds can be classified according to how the assets are managed; for instance – Passive versus Active Funds. Passive EFT Index funds such as the Lotus Halal Index Fund index funds are not actively traded. The Mutual Fund Managers buy the index of the stock exchange and simply rebalance their positions as desired. This is a way for the investor to gain exposure to a particular market, sector, or even nation.
Actively managed funds on the other hand like the Legacy Equity Fund will see the Mutual Fund Managers actively buying and selling shares to maximise returns on behalf of the fund investors
Mutual Funds can also be classified by the asset allocation thus;
Mutual Funds can also have a hybrid or mixed portfolios investing in different classes of assets. for instance, a fund can have both fixed Income assets like Bonds and Variable assets like Shares. Examples of these are balanced funds like the AIICO Balanced Fund.
Target date funds also called Lifecycle funds hold a mix of stocks, bonds, and other investments in separate funds differentiated by maturity dates. Over time, the asset mix gradually shifts from variable income to fixed income in line with approaching retirement of the Fund Investors. An example of this is the Cordros Milestone Fund.
How Do Investors Make Money in Mutual Funds?
The Mutual fund Manager invests the assets of the fund in s fiduciary manner for the investors to the Mutual fund. Increases in the Assets held by the Mutual Fund will increase the price of the fund leading to Capital Gain. Some Mutual funds also pay a dividend or distribution to the fund investors. So when you invest in a Mutual Funds, you receive the same rise in asset prices and returns as if you invested in the assets directly but proportional to your holdings in the Mutual Fund.
Investors buy mutual fund shares from the fund itself or through a broker for the fund, rather than from other investors. The price that investors pay for the mutual fund is the fund’s per share net asset value plus any fees charged at the time of purchase, such as sales loads.
How are Mutual Funds Valued?
Every close of the trading day, each mutual fund is valued. This value is expressed as the Net Asset Value and is derived by dividing the total value of all the securities in the portfolio, less any liabilities, by the number of fund shares outstanding.
Things to do before investing in any mutual fund
Read the prospectus, that will tell you the “constitution of the fund including the asset management goals and objectives
Ask about fees you will pay, fees are a drag on your profitability
Ask how the fund will manage profits? Dividend payout?
How quickly can you get your funds if you decide to leave the fund
Do past performance matter? Past performance of any investment cannot be used as a predictor of future values, at best they can give the investor a glimpse into the operations the company e.g. how they treat cash earned.
Even small differences in fees can mean large differences in returns over time. For example, if you invested $10,000 in a fund with a 10% annual return, and annual operating expenses of 1.5%, after 20 years you would have roughly $49,725. If you invested in a fund with the same performance and expenses of 0.5%.
Editor’s Note: It should be noted that this is not an offer to buy or sell securities. Mutual Funds can be risky even as investors could lose invested capital. The Mutual Funds that were mentioned are for illustrative purposes not a recommendation of any sort.