You must have heard of the term mutual funds and thought of it as some complex financial concept. With all of the uncertainty about them flying around, they may sound like a lot to deal with but here, we will demystify mutual friends and get you up to speed with all you need to know.
Basically, mutual funds are a certain number of people collectively depositing/putting in money for a common interest.
This can also be seen as a kind of investment vehicle where a group of investors pool in their money and hand the total amount to a professional manager who ensures that the money is invested in different types of assets. One of the benefits is that the investments are synonymous with eggs being placed in different baskets. Hence, the risk of losing money is considered minimal.
Before you get started on mutual fund investments, ask yourself a few questions like,
What are your Goals?
It is important to ask yourself what you intend to gain by investing in mutual funds. Is it to create wealth or targeted goals like getting a new house, retirement, or marriage. Being quite clear on your goal is essential as this will determine the investment horizon – long term or short term because buying a new car is more likely a short-term goal than saving for retirement.
How huge is your risk appetite?
Just like humans are different and fingers aren’t equal, different investors are interested in different levels of risk exposure. If you can identify how huge your risk appetite is as regards investments, the mutual funds which you intend to invest in can be based on your risk preference.
What is your preferred mode of investment?
You can either choose a systematic investment plan. This allows investors to invest small amounts periodically. You could also invest via a lump sum amount. Although, a systematic investment plan helps you modify risks overtime which helps in terms of tackling market volatility to a certain degree.
Pros And Cons Of Mutual Funds
Pros:
Mutual Funds Are Straightforward
You require zero experience or knowledge of finance to be a successful investor.
Mutual funds like every other financial product has its intricacies but when compared to the others. It is easy to use and understand.
Mutual Funds Are An Easy Buy
They are offered at brokerage firms, discount brokers online, mutual fund companies, banks, and insurance companies. New investors can open an account at a no-load mutual fund company easily.
A mutual fund load is an amount paid to buy or sell a mutual fund. Funds that charge loads are usually known as “load funds” and funds that do not charge loads are called “no-load funds.”
Mutual Funds Are Diversified
With a single mutual fund, you can invest in dozens, hundreds, or thousands of various investment securities and this helps in achieving diversification by investing in just a fund. Although, diversifying into several mutual funds can be a smart move.
Mutual Funds Have Varying Categories
The more you grow your mutual funds’ portfolio, diversifying into different mutual fund categories is only normal. Mutual funds that cover core asset classes like stocks, bonds, cash can be invested in or unique areas such as sector funds or precious metal funds.
Mutual Funds Are Cheaper To Maintain
When transaction costs are summed up and annual fees of a brokerage firm are paid including the price of research tools or investment advice, Mutual funds are typically cheaper than the usual portfolio of stocks.
Mutual Funds Have Independent Professional Management
One of the most interesting things about mutual funds is that investors do not need to waste long hours or energy on any research and analysis needed to get great investments to hold in a portfolio. With mutual funds, investors can live the life they want rather than spending all their time on investment matters. How reassuring!
Mutual Funds Are Flexible
These above advantages of mutual make them simple and flexible. You can choose to invest in one fund or in a variety. Mutual funds have endless investment strategies like systematic withdrawal, automatic deposit, short-term savings, long-term savings…these make mutual funds one of the best investment types for newbies and longtime investors.
Cons:
Mutual Funds Have Invisible High Expense Ratios
Mutual fund expense ratios and sales charges can get out of hand if you do not pay attention. It is advisable to be wary when investing in funds with expense ratios that are higher than 1.20% because they are most likely to be on the higher cost end. There are many good fund companies with no sales charge. Total investment returns can be reduced by rates.
Steps To Building Your Mutual Fund Portfolio
Shares of a collection of stocks, bonds, or other securities purchased by investors in a mutual fund are referred to as portfolios.
Just like building a house, you need a blueprint to build your mutual fund portfolio. It requires various types of strategies, tools, and building materials but each structure has common features.
The best way to build a good portfolio of mutual funds is by remembering not to put all your eggs in one best. You also need a structure with a strong foundation,well-put design, and a basic combination of mutual funds that will be great for your needs.
- Core and Satellite Portfolio Design
The first step to building a portfolio design is a blueprint. One classic portfolio design is known as Core and Satellite. It works exactly like its name. First, start with the core which is a large-cap stock fund that represents the biggest portion of your portfolio which builds around the satellite which represents the small portions of your portfolio
- Make Use Of Various Types Of Fund Categories
You already have a large-cap stock fund as your core, therefore different types of funds(satellites) will complete the structure of your mutual fund portfolio.
- Know The Rate Of Your Risk Tolerance
It is essential to know how much risk you can tolerate before choosing your funds. Your risk tolerance is typically how much market risk you can handle. If you are easily shaken by a drop in your account balance or when your account value drops then you have a relatively low-risk tolerance and can’t stand high-risk investments.
- Know Your Asset Allocation
If you can figure out your level of risk tolerance, you can know your asset allocation.
Your asset allocation is a combination of investment assets that comprise stocks, bonds, and cash that make up your portfolio. The reflection of your level of risk tolerance is directly proportional to proper asset allocation. Your risk tolerance can either be aggressive (high tolerance), moderate (medium risk tolerance), or conservative (low tolerance).
Your stocks will be more in relation to bonds and cash in your portfolio if your risk tolerance is higher and the percentage of your stocks in relation to bonds and cash will be less if your risk tolerance is lower.
- Figure Out How To Choose The Best Funds
You know your asset allocation; the next step is picking the best funds for you. If you are finding it difficult to make a choice, it is wise to use a fund screener. These are available on multiple websites and trading platforms allowing users to select trading instruments that are right for a particular criteria profile. Considering essential qualities of mutual funds like fund fees and manager tenure is also important.
As a beginner, you may like the right amount of money to meet the minimum initial investment amount. If you can only afford to meet the minimum for just a fund begin with a balanced fund. A balanced fund is a kind of mutual fund that contains both stocks and bonds. As soon as you have gotten the first fund for your portfolio, you can now save money to purchase the next fund and then you can go on to build your portfolio one fund at a time. To get ahead real quick, you can save yourself the stress and get a fund manager to show you the ropes.
Types Of Mutual Funds For Investment
In simpler terms, mutual funds work almost like a shared apartment where members split the rent for the purpose of owning the same space. Mutual funds come in different types.
These are a few mutual fund ideas for investment.
Here, the funds are invested in short-term fixed-income securities like government bonds, treasury bills, bankers’ acceptances, commercial paper, and certificates of deposit. These are typically a safer investment with a lower potential return than the other types of mutual funds.
- Fixed Income Funds
Fixed income funds purchase investments that pay a fixed rate of returns like government bonds, investment-grade corporate bonds, and high-yield corporate bonds. The aim of this is to have money coming into the fund regularly and chiefly through the interest that the fund earns. Corporate bonds with high yields are typically at a higher risk than funds that carry government bonds.
- Equity Funds
They grow faster than money market or fixed-income funds, hence, there is a generally higher chance that you could lose money. Equity funds invest in stocks. There are different types of equity funds you can choose from and they include those that are geared towards growth stocks and these don’t usually pay dividends, income funds (these hold stocks that pay huge dividends), value stocks, large-cap stocks, mid-cap stocks, small-cap stocks or a combination of all these.
- Balanced Funds
Balanced funds invest in a combination of equities and fixed-income securities. They aim at balancing the attainment of higher returns against the risk of losing money. Most of these funds adhere to a certain method to share money among the various types of investments. Balanced funds have a higher risk than fixed-income funds but less risk than equity funds.
- Index Funds
These are focused on tracking how well a specific index is doing. The value of the mutual fund is directly proportional to the index. They usually have cost lower than actively managed funds. This is because the portfolio manager doesn’t do so much research or make a lot of investment decisions.
- Specialty Funds
Specialty funds aim at unique mandates such as real estate, commodities, or socially responsible investing. For instance, a socially responsible fund may likely invest in companies that are big on human rights and diversity and stay off companies that are involved in tobacco, gambling, and weapons.
- Funds-On-Funds
These resemble balanced funds. Here, they strive to make asset allocation and diversification easier for the investor. These funds invest in other funds.
After all is said and done, mutual funds are excellent and allow many people into the market – people who usually have no interest in investment and it increases the volume of markets which typically is of huge benefit to the populace.
We, at Quantum Zenith Asset Management, have the answers to all your mutual fund questions and more. Contact us today to get the right insight into investing in mutual funds.