Mutual Funds: How It Work & The Various Types Available
In this post, you will learn about the types of mutual funds and how mutual funds work. So what are Mutual funds? Mutual funds are baskets having different types of funds which are normally invested in stocks, bonds, money market instruments, and other assets. Mutual funds allow people to invest and reduce the risk of picking individual securities.
Also, most Mutual funds managers do the tough work of picking the investment type instead of letting an individual investor perform this difficult task. Besides, Mutual funds have expert fund managers who charge a fee and some other charges to the managed funds. There are generally four types of mutual funds. You have those that invest in stocks (equity funds), bonds (fixed-income funds), short-term debt (money market funds) or both stocks and bonds (hybrid funds).
Furthermore, all mutual funds try to spread the risk by diversifying their portfolio to let them make more gains than losses. Not all funds have equal risks. Risks depend on the area the mutual chose to invest your money. To learn more, here is a full guide on the types of mutual funds and how mutual funds work.
How Mutual Funds work
Mutual funds pool your money and many other people’s money to invest it in a portfolio of assets like stocks and bonds. When you invest in a mutual fund, you can now buy portfolios that you would not be able to buy on your own alongside other investors.
For example, there are different sizes of mutual funds you can invest in. You have the large-cap, mid-cap, and small-cap mutual funds. Also, there are mutual funds that focus on biotechnology, communication, and so on.
Another reason Mutual funds are popular is that they let you select one fund, that contains different stocks, and you don’t have to worry about diversifying your portfolio or putting all your eggs in one basket as you would if you invested in stocks on your own. These Mutual funds are diversified on their own because they buy different stocks from different sectors of the economy.
How These Mutual Funds Are Run
As you think of the types of mutual funds that you can invest in, you would also like to know how they are run. Besides, they are also called managed funds because they have professional fund managers that select the assets in that mutual fund portfolio.
Also, because they select the investment and manage the portfolio in the fund, you call the funds managed funds. They charge different types of fees for managing the mutual fund. And when you invest your money, they try to manage it well because if the fund does not make a profit, their jobs will be at risk.
Distribution Of Earnings On Your Investment In A Mutual Fund
Because you cannot predict what will happen to you the next minute, experts that manage different types of mutual funds, cannot predict that the assets they selected for the mutual fund will make a profit.
In a report by Dow Jones, 66% of large-cap (big company) mutual fund managers failed to beat the S&P 500 in 2016. When the same report extended the research to fifteen years, up to 90 per cent failed to beat the market.
But, if they do well they will pay you in two ways.
- The first is by Distribution – If the fund invests in companies that pay dividends.
- And the next is Capital gains – when you sell your mutual fund.
Advantages Of Investing In A Mutual Fund
- You don’t actively watch over your investment.
- Because they buy different companies if one fails the other may do well
- You use mutual funds to diversify your investment.
Disadvantages Of Investing In A Mutual Fund
- Many debit their expenses to the fund and charge fees upfront.
- If you invest in two mutual funds that are bought, Facebook stocks for instance and Facebook shares fall in value, your investment will be hit twice in the different Mutual funds. So your investment is now at risk and less diversified.
- You pay experts to manage your money when research shows that they hardly beat the market.
Types Of Mutual Funds
There are different types of mutual funds and each has its own pitfalls. You may select a Mutual fund due to different factors. They are a risk, return, sector, geographic area of investment, and so on. For example, you can invest in a fund that invests mainly in different energy services. You may also invest in a fund that buys only emerging markets, or one that focuses on medical devices.
Also, some mutual funds choose to be socially responsible and will not invest in controversial industries like tobacco and firearms. They instead choose to buy companies that have good labour and environmental practices.
Besides, the mutual funds invest in the following segments. Each option has its benefits, pitfalls, and clauses. So go through them so that you know which mutual funds to invest in.
1. Money Market Funds:
They are short term funds of less than one year in securities that the US government sells. They are Treasury securities like CDs or Commercial papers issued by large corporations. These securities earn very low returns.
They are fixed-income Funds. These are debt instruments that a company issues to an investor They have higher returns than money market funds but are riskier. Also, because interest rates influence all bonds if, the rates go down the value of the bonds will go down.
3. Equity Funds:
You can also call it stock funds. This is one of the most popular types of mutual funds. Mutual funds invest in the stock of large-cap companies like Google or Apple worth over $10 billion or more, mid-cap companies with a valuation of $2 to $ 10 billion or small-cap companies worth $300 million to $2 billion.
4. Hybrid Funds:
These funds are mixed and have stocks, bonds, and other kinds of investments. Also, some Mutual Funds invest in other Mutual Funds.
5. Index Funds:
Index funds track or follow a specific market index, like the S&P 500. Also, Index funds are now popular but like equity funds. Besides, the index funds vary by their size, sector, and location.
6. Specialty or Alternate Funds:
These funds contain all kinds of funds like managed futures. They include hedge funds, commodities, and real estate investment trust.