What is a mutual fund?

An investment company consists of a pool of cash that’s collected from several investors to take a position in securities like stocks, bonds, securities instruments, and different assets. Mutual funds are registered with the Securities and Exchange Commission (SEC) as corporations. The funds offer diversification and professional management and may include good sort of investment strategies and designs.

How do mutual funds work?

There are two ways investors can invest their money. One way is either directly understanding the financial markets, studying and learning about each investment type and investment or the second method is they can connect with a financial expert and give him the funds and let them decide the proper investments which suit our goals. These second steps fall under the name of Mutual Funds.

Types of mutual funds

Mutual funds divide into many forms of classes that represent the kinds of securities they need based on investors’ goals and their risk and reward goals. Based on their approach the fund type, fund maturity period and investment amount. In Srilanka, there are three main types of mutual funds which are commonly used by investors.

• Equity Mutual funds

Equity funds are mostly invested in stock markets. These kinds of funds have big capital and always invest in long-term goals. These funds mostly have a set of terms and conditions to follow and have a high-risk high return ratio. Before investing in equity funds learn about past performance, expense ratio and exit load.

• Index Mutual funds

Index funds are invested in index stocks. There are indexes like ASPI and S&P SL20 in Srilanka. ASPI means All share price Index and S&P SL 20 means a group of selected 20 best performing stock companies in Srilanka. If you choose to invest in S&P SL 20 index fund then the funds are invested into the specific index category like your money is divided into the best 20 companies’ shares.

Index funds also have the same risk-reward ratio as investing in the share market and are focused on long time goals but the fact is your funds are invested into some best-performing companies. Which was analyzed for a long period of time and included in the index of S&P SL 20. Even though the billionaire investor Burren buffet recommends beginner investors to try index funds for a long period of time.

• Income Mutual fund

Income funds mostly vary from asset management company to company. Mostly it will invest in Bonds and commercial papers. It has a low risk and low gain ratio. The goal is to create a fixed income stream for your investment over time. The popular income fund scheme is “Unit funds”.

Other than this there are different types like growth funds, debt funds, bank funds, solution-oriented funds etc.

Advantages of mutual funds

There are reasons why mutual funds differ from other types of investment opportunities and they have the great potential to increase money over time to beat inflation.

• Diversification

Diversifying the investment is a very important rule in investing. There is a saying called “Don’t put all your eggs in the same basket”. In mutual funds, most of the money is divided into stocks, bonds, commercial papers, and various investment types. It has a very disciplined control over risk management and risk management is very important in any investment.

• Liquidity

Mostly mutual funds are focused on long-term goals. But they don’t have a maturity period like fixed deposits have. Mutual funds mostly have good liquidity. You can exit anytime from your mutual fund scheme if you want. But in some terms and conditions, it can cost an additional exit charge. But in any emergency cases, you can access your funds quickly within 1-3 days time.

• Professional management

A key good thing about mutual funds is that you just do not have to decide on stocks or manage investments. Instead, an expert investment manager takes care of everything through careful analysis and skilful action. Those investors who don’t have the time and effort to study financial markets and just want all things to be monitored by some financial experts can get into mutual funds.

• Minimum investment necessities

Mutual funds are collected from various investors and invested as a big pool therefore mutual funds need a lot of lower minimum investments. Thus, these funds supply a cheap approach for personal investors to experiment and hopefully enjoy skilled money management.

Disadvantages of mutual funds

• High fees, commissions, and different fees.

Some types of mutual funds have high expense ratios and exit loads. This can carry out a lot of money. There are some asset management companies that charge a low amount.

• Difficulty in comparison of funds

When your money is diversified asset management divides your money into specific investment methods which may not seems well although you may don’t like it. It leads your portfolio to the negative side and decreases the profits made by positive investments.

• Lack of transparency in the operation

Most companies offer an annual report about what are the companies they invested in and the profits and losses made by each investment. But some asset managements don’t offer a fully transparent report about the loss and gains. So choosing the right asset management company is important to get a transparent report on where is your money going.

Things to consider

• Choose the right asset management company is important thing in mutual funds
• Compound interest and consistency is important in any investments
• Get a report on where the funds invested in and analyze the performance
• Be in touch with your assigned financial manager for more details and current risk reward factors
• Always focus on long term and don’t invest the money which you can’t afford to lose.