Investing in Mutual Funds
The benefits of investing in Mutual Funds
If you are looking for somewhere other than your bank or building society account in which to put your money, you are likely to be doing so because of the present derisory returns available on deposits. So, what are your options? There are Individual Savings Accounts (ISA) that provide tax-free returns, but again, the interest rates are not exactly thrilling. You could invest directly in company shares listed on the Stock Exchange in the hope of capital growth or regular dividend payments. That does, however, carry an element of risk. If a company in which you have invested falls on hard times, so will its shareholders. You could lose some or all of your investment if the company goes into administration.
There are other options. If you are courageous, you could invest in cryptocurrencies. A more popular choice is forex trading, where traders make profits on the movement of one currency against another. If you decide on that route, you must find a reputable and reliable broker to handle your trades.
How investors protect themselves from investment calamities is to diversify their holdings. That is to spread the overall shareholding across several business sectors, degrees of risk and types of companies. To adequately diversify the portfolio should include in the region of 20+ companies. In that way, if one company fails, the overall share portfolio is not terminally affected; however, adequately diversifying a portfolio can be expensive. If your capital does not stretch to investing in several companies across various sectors, what other option is there? There is, in fact, an excellent option available in such circumstances – Mutual Funds.
What are Mutual Funds?
- Mutual Funds are a group investment vehicle in which investors pool their money that is then invested in a range of securities.
- They provide all the investors in the fund with the all-important diversification previously mentioned.
- The expenses involved in the trading of the securities is split across all the participants, thereby reducing the costs for the individual.
- The funds are managed by experts (money managers), so the individual investors do not have to worry about deciding where and in what to invest.
- They are a convenient form of investment, accepting both capital sums and monthly payments.
- Different funds have different objectives and degrees of risk.
- The range of funds available is extensive.
- Socially responsible investing is available.
That sums up what these funds are and their purpose. Let’s now look at this in more detail.
When capital is held in a mutual fund, the risk is reduced because of the diversification of the portfolio. The risks that remain are those that would affect investors market-wide if they occurred. Major adverse geopolitical events, a stock market crash, or a world economic recession being the primary examples.
Mutual funds are advantageous because they allow small investors to diversify their holdings instantly. Small amounts of cash can be invested in one or more funds with different objectives (capital growth or dividend income), so spreading the risk even further. Many funds hold shares in a broad range of industries, including; health care, pharmaceuticals, technology companies, banks, financial institutions, and utilities.
The funds are also convenient for investors, and that is one of the main reasons they are so popular. They can provide the equity portion of an overall investment strategy without going to the trouble of buying the shares directly. By leaving the buying and selling choices in the hands of the experienced fund managers, they rid themselves of the commitment in the time that is required for market research and the monitoring of assets. Doing that research thoroughly and watching the markets can be very time consuming and is something with which some investors cannot be bothered.
Many of the funds provide investors with a choice of the industry sectors in which they can invest. They are also given a choice between funds focussing on growth or income or a mixture of both.
Here are some examples of fund types:
- Bonds – these funds invest in corporate and government bonds and other debt instruments to generate a monthly income.
- Growth – capital appreciation is the aim. Managers seek out companies that are likely to provide above-average growth in the longer term.
- Sectors – targeted on an area of the economy or a chosen industry.
- Value – investment in undervalued companies for the longer term.
- Index – these funds attempt to track the overall market by creating a portfolio of shares to match the market index.
By using mutual funds, investors can save money on dealing in individual shares. Money can be saved by using a broker that charges lower fees, but if an investor regularly makes a lot of trades, it can reduce gains. That is avoided by using a mutual fund because the management and trading costs are spread across all participants.
As with any investment that is linked to the stock market, the advice is to ensure that safer forms of financial management come first. Having savings in tax-efficient savings accounts or National Savings and Investment (NS&I) vehicles should take priority before embarking on more risky investments.
Of course, investing via mutual funds is not for everyone, and it is essential to remember that as with any form of investment, money can be lost or expected returns not materialise. That having been said; mutual funds have been around for a very long time and have served millions of investors very well.