There might be considerable confusion about the exact definition of mutual funds especially to laymen who do not understand technical jargon. But, there is no need for confusion. The simple definition of mutual funds is as follows: it is a professionally managed kind of collective investment plan that pools funds from various investors, investing it in bonds, stocks or other assets. The combined holdings of the bonds, stocks and other assets are termed as portfolio. Each investor holds shares, which forms a portion of the holdings.
Mutual funds may invest in various kinds of securities: cash instruments, stocks, or bonds. There are various sub-categories as well. Stock funds can be invested principally in the shares of a specific industry, such as technology or utilities. These are known as sector funds. A professional manager always supervises mutual funds portfolios and monitors, as well as forecasts, the cash flow in and out of the fund by the investors and checks the future performance of the investments. He or she also chooses those investments that will follow closely the mutual funds investment objectives.
There are three ways to make money out of mutual funds:
You can earn from dividends on stock or interest on bonds. The fund pays most of the income it gets through the year to fund holders as distributions.
If the fund sells a security that has become more valuable, it makes a capital gain. This profit is usually distributed amongst the investors.
If the fund holdings increase in price, but the manager does not sell them off, the value of the fund’s shares increase. You can then sell your owned shares to make a profit.
The fund will also provide you the option of receiving a check for the distribution or reinvest your money/earnings to buy more shares.
Advantages of mutual funds:
* Professional management: – a mutual fund is a great way to let a professional handle your money if you do not have the time or expertise to devote to your stocks. A mutual fund is the least expensive way for a small investor to hire a full-time manager to take care of your money and make investment decisions.
* Diversification: – with mutual funds, you get the chance to spread out your money over a huge range of fields and sectors, which is impossible for a small investor on one’s own. The risk therefore is spread out. The more stocks you own in different areas, the lesser the chance of loss.
* Economies of scale: -Transaction costs are much lower as a mutual fund buys and sells large amounts of securities at a time.
* Liquidity: -Like individual stock, mutual funds stock can be transformed into cash at any time.
* Simplicity: -investing in a mutual fund is easy when you understand the definition of mutual bonds. Banks usually have their own line of mutual funds and the minimum investment required is small. Even as little as $100 dollars might be invested on a monthly basis.