Anyone interested in business or finance should learn about mutual funds. These popular financial products offer investors a convenient way to make money that doesn’t require a lot of upfront capital. Mutual funds are diverse collections of securities managed by professional investment advisors, and they’re extremely popular, because they allow people to invest a relatively small amount of money in a wide range of securities, including stocks, bonds and certain types of debt.
Mutual Fund Basics
There are four types of mutual funds, and depending on your financial goals, you can buy shares in a money market fund, stock fund, bond fund or target-date fund, according to the US Securities and Exchange Commission. The fund with the lowest risk is the money market fund because, by law, firms can only invest in short-term debt and securities issued by state, local or federal governments or U.S. corporations. Bond funds are also relatively low-risk, but because they vary widely, some bond mutual funds do have a real risk of losing money. In general, it’s possible to lose money in a mutual fund because the net asset value, or NAV, of a fund fluctuates over time.
Most experts say to pay attention to a fund’s long-term performance rather than its short-term gains, because a mutual fund’s NAV must be averaged over a period of three to five years to accurately judge its performance. Stock funds are one of the most diverse types of mutual fund, and putting money in one of these investments allows you to have a much more diverse portfolio than you could by purchasing shares of the same stocks through a broker. However, buying shares in a mutual fund doesn’t make you a stakeholder in the companies whose stock is owned by the fund. The bank or investment firm owns the stock and manages the investment according to a strategy developed by a team of financial researchers.
Costs and Earnings
Because there are so many people working together to make the investment successful, there are substantial costs that investors must pay before they receive their returns. By law, firms must publish their goals, strategies and investment costs in a prospectus, and before buying shares in a mutual fund, it’s very important to read its prospectus. A difference in cost of one percent can make a big difference in the long-term gain of a fund, and a higher cost doesn’t necessarily indicate a better chance of earning money.
Mutual funds earn money in several ways, and depending on the type of fund you invest in, you can be paid monthly, yearly or at the end of a longer investment cycle. In a stock mutual fund, you can earn dividends that are paid at the end of the year, and in a bond mutual fund, you can earn interest on the bonds. When the securities in a mutual fund increase in value, the NAV of the fund goes up and investors receive a capital gains distribution. There may also be capital losses, and these losses are subtracted from the payment.
Related Resource: Credit Risk Analyst
Investing in financial products always carries a risk, and the safest investments usually don’t earn very much money. Managed investments offer average investors a way to take bigger risks without spending years studying finance, but these risks can cause losses as well as gains. If you’re looking forward to retirement or saving for your child’s education, mutual funds are often a good investment.
