A Mutual fund, or an investment fund as it is often called, is made up of a combination of stocks, bonds and other securities.
A Mutual fund company brings together a group of professional investors and investment analysts which invest their money in stocks, bonds, and other securities. Investors who purchase such funds, own shares or units as they are often called, representing a portion of the holdings of the fund.
There are three ways investors can make a return from a mutual fund:
- Investors can earn income from dividend on stocks and interest on bonds. A Mutual fund company pays out nearly all of the income it receives over the year to fund owners in the form of a distribution.
- Where the fund company sells securities that have increased in price, the fund has a capital gain. Most fund companies also pass on these gains to investors in a distribution.
- If and when fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. Investors can then sell their Mutual fund shares for a profit.
Advantages of Investment funds
- Professional management by qualified professional investors and analysts.
- Many investors purchase funds because they do not have the time or the expertise to manage their own portfolios.
- An investment fund is a relatively inexpensive way for a small investor to get a full-time management team to make and monitor their investments.
Diversification – When investors own shares in an investment fund instead of owning individual stocks or bonds, their risk is spread out and significantly reduced (diversification allows investors to participate in a large number of assets so that a loss in any particular investment is minimized by gains in other investments).
Economies of Scale – Because an investment fund buys and sells large amounts of stocks and bonds regularly, its transaction costs are lower than what an individual would pay for his/her securities transactions.
Liquidity – Just like an individual stock, an investment fund allows you to request that your shares be converted into cash at any time.
Simplicity – Buying an investment fund today is made easy! Individuals can open an account with as little as $500 and most companies offer automatic purchase plans with as little as $100 invested on a monthly basis.