What is a mutual fund?
A mutual fund is professionally managed by a portfolio manager, who adds tweaks and changes to the portfolio in order to meet the fund’s objectives. Mutual funds are a great option, as they enable individual investors to diversify their portfolio through a single fund.
However, mutual funds come with fees and expenses (although in the grand scheme of things, these are usually pretty small). If you haven’t started investing yet and don’t know where to begin, a mutual fund is a good starting point! Managing a portfolio yourself is time consuming and requires a fair bit of knowledge – a fund manager takes all that pressure off, meaning you can kick back and relax.
KEY TAKEAWAYS
- A mutual fund is a basket of commodities, bonds, equities and other financial assets which a group of people pool their money into
- As an investor, you own part of this pool corresponding to the amount you have invested
- They are typically managed by an expert who makes trading decisions in order to meet the fund’s objectives
- There are two types of mutual funds: active and passive
- You can purchase shares through the fund directly, or through a broker for the fund
Active vs passive fund
There are two types of mutual funds: active and passive. An active mutual fund is when a fund manager manages the pool of assets for you in order to get the best return. A passive mutual fund, on the other hand, is when you track a benchmark market index (e.g. the FTSE 100 or S&P 500). While an active mutual fund is focussed on beating the market index, a passive approach means you are simply trying to match it.
How to invest in mutual funds
Since mutual funds are not traded publicly on the stock exchange, it’s not a case of downloading a trading app and purchasing from other investors. Instead, you need to purchase shares through the fund directly, or through a broker for the fund. Here are your options:
- Broker: A broker will guide you through the entire process, offering guidance on which schemes you should invest in and actually setting up the fund. There is a fee for going through a broker, which is usually deducted from the total investment amount.
- Visiting the fund branch: You can visit a fund branch and set everything up. You will be required to have the necessary documents with you, so make sure you know which ones to bring!
- Online through the official fund website: Most fund houses now allow people to make their investments directly online. This is a much preferred method amongst investors as it’s generally more hassle free.
- Through the official app: Most funds will also have apps where investors can buy or sell units, view account statements, and check other details related to the portfolio.
Types of mutual funds
- Money market funds: Short-term low-risk securities, such as government bonds, treasury bills, and certificates of deposit. They generally have low returns which are paid in the form of dividends.
- Bond funds: A fund that invests solely in bonds. Because there are many different types of bonds all holding different risks, rewards fluctuate.
- Stock funds: Invest in a variety of corporate stocks include the following:
- Growth funds focus on stocks that may not pay a regular dividend, but have potential for above-average financial gains.
- Income funds invest in stocks that pay regular dividends.
- Index funds track a particular market index such as the Standard & Poor’s 500 Index.
- Sector funds specialise in a particular industry segment.
- Target date funds: Made up of a combination of stocks, bonds, and other investments to meet the individual person’s goals and, therefore, strategy.
ETF vs mutual fund
An ETF (Exchange-Traded-Fund) is a spin off of a mutual fund. The main difference is that unlike mutual funds, ETFs track a market index (such as the S&P 500) and are traded on stock exchanges. This means they can be bought and sold at any point during the day and generally carry lower fees. In that sense, ETFs are passive funds which do not require stock analysis from the fund manager.
On the other hand, a mutual fund is actively managed, as it requires a fund manager to build an optimal portfolio rather than just following an index. ETFs have therefore become an increasingly popular alternative to the mutual fund due to their convenience and flexibility.