It is always advisable to choose Mutual Funds when one doesn’t have the investing knowledge, stamina, and patience to invest directly in the stock market. Rather than idly sitting on the cash, Mutual Funds can be a great and less risky way to make the cash work for you and make gains on the principal amount. These gains, when reinvested in the same fund, can become a great compounding machine.
Mutual Funds have served several purposes.
- Promoted good habits of savings and investments
- Protected countless individuals against costly mistakes in the stock market
- Brought investors income and profit commensurate with the overall returns from the common stocks.
However, investing in funds cannot be considered a no-brainer, especially when there is a plethora of fund types available in the market. Just like stock, funds have a risk level associated with them. Funds can be broadly categorized into high-risk (with a major portion of money invested in stocks), balanced (equally invested in stocks and bonds), and low-risk types. Therefore, it is equally important to understand which funds suit one’s taste.
Some people dare to invest in high-risk funds, which, in the good years, can return hefty returns. Others prefer to invest in balanced or low-risk funds, which, over the years, return favourable gains on the principal amount.
When investing in Mutual Funds, the key question is which options will provide a strong return over an extended period. However, with the wide variety of Mutual Funds available, it can be challenging for the average individual to select those that will effectively grow their principal investment and that is better suited to their investment objective.
In this post, I will provide a brief overview of the fund’s purpose, types, charges, the selection of appropriate funds, and how to avoid risky funds.
Table of Contents
Disclaimer
Before digging into the details of the funds, as usual, I would like to say that these contents are meant for educational purposes and do not serve as investment advice. Please do your own due diligence when planning to invest in funds.
Understanding Mutual Funds
Before investing in mutual funds, it is essential to understand the purpose they serve. Knowing the purpose of the funds is the first step to categorizing them. In the last decade, several funds have been introduced into the market. For example, certain funds provide monthly cash dividend income. If one wants to generate a monthly income (similar to bonds), then these types of funds may suit their taste. On the other hand, some funds invest heavily in stocks and risk-based assets that provide hefty returns in good years and small returns in bad years. If one prefers to avoid the nuisance of the market’s ups and downs and does not want to jeopardize their peace of mind by researching individual stocks to gain hefty returns, this type of fund may suit their taste.
At this point, it is equally important to understand that the fund returns may not be the same every year or every month. In some years, the funds may shine by returning great profits to their investors, while in other years, they may give below-average returns. There are funds in the market that promise high returns based on their 2-, 3-, or 5-year performance, but they struggle in the long term and even incur substantial losses. As a result, care should be taken when deciding to invest in funds based on past performance, as they may or may not repeat in the current or upcoming years.
Funds may provide dividends in the form of cash or shares that can be reinvested in the same funds. This helps to compound the returns over a long period. However, not all the funds provide dividends. It is also important to note that funds (except for those that provide monthly income or quarterly income) that provided dividends in the past may not provide them in the future.
It is not necessary to focus on only one type of fund. As mentioned above, fund performance throughout the years does not remain constant. Some funds perform better in one year while struggling in the other year. Conversely, the funds that struggle in some years may perform better in the upcoming years. The reason for this discrepancy in the performance of various funds is the market sector in which they are invested.
Funds are managed by fund managers, each of whom has a different skill set, investment appetite, risk tolerance, investment expertise, and favourite market sectors. Each fund is either invested in a specific benchmark index or lists its top 10 or 20 investments (stocks of companies) in its prospectus. However, it should be noted that fund manager investment across the companies in the benchmark index or in the top 10 investments may not be uniform. The fund manager, over the years, may change the investment proportion in each company based on his expertise, without informing the investors.
Funds categorization
Funds can be broadly categorized into two types
Closed-end funds are non-redeemable, whereas open-ended funds, also known as mutual funds, can be redeemed by the holder at their net asset value. What that means is that an investor can choose to invest and withdraw their investment from the funds upon request. However, the investment and withdrawal requests may take a few working days to process.
Fund Types based on their Holdings
When it comes to how the funds invest your money, you need to make sure whether it is a balanced fund or a stock fund.
- A balanced fund is a low-risk, low-reward fund that puts at least one-third of its assets in bonds.
- A stock fund is a high-risk, high-reward fund that puts nearly all of its assets in stocks.
Fund Charges
When you invest in a fund, the fund will charge you a certain amount to manage your money. Usually, it’s a small percentage (less than 1% of your investment amount). But one needs to know the type of charges they have to pay to invest in a fund.
A load fund will have two types of charges
Front-end load: A percentage of your investment amount when you buy the shares of the funds you are investing in. Let’s say you invested $10,000 in a fund that charges 9% as a front-load fee. In that case, your overall investment amount in a fund will be $9100 (10,000 – 0.09 x 10,000).
Back-end load: A percentage of your invested amount when you sell the shares of the funds you invested in. Let’s say you invested $10,000 in an investment fund. After a few years, your investment gives you a 50% return ($5000) on the principal amount. Now you want to sell the shares of your funds, and the fund’s back-end load is, let’s say, 3%. Then you need to pay $450 when selling the shares of the fund, and you are left with $14,550.
Performance Funds
I would like to mention one particular category of fund, the performance funds. What is the performance fund?
A performance fund is focused on capital gains. Most of its investments are concentrated in growth stocks. The following are the characteristics of the performance funds:
- A fund manager tried to get better-than-average returns over a short period of time by investing in risky assets.
- Their definition of a sound investment is that the stock will likely rise in the market in a few months.
- This leads to investment in the stocks whose selling prices are disproportionate ot their assets or recorded earnings.
However, one should be cautious about such funds as they may perform better for a few years, but in subsequent years, they may not maintain their profitability, as the fund’s performance is highly dependent on the market.
How to Open an Account for Fund Investment
Usually, banks or separate financial institutions (brokerage firms) provide the fund investment services. To invest in funds, one has to open a brokerage account with a bank or other financial institution. Most trading apps, such as IBKR, Webull, RobinHood, and banks, provide brokerage account opening to invest in funds.
At this point, I believe that readers of this article have acquired certain knowledge about investment in funds. It is also important to note that fund investments might not return the gains one would expect to achieve from investing in stocks. Nevertheless, investing in the funds is considered to be less risky than directly investing in the stocks. Investing in stocks requires its own expertise. One can refer to my following article titled “A Beginner Guide to Stock Picking in 2025” and another article titled “Which Investment Style is Right for You? An Overview” to know more about stock investments. Stock investment may look attractive at first glance; however, it carries huge risks and requires careful deliberation and study of the companies.
I hope this article may have helped you get basic knowledge about fund investment. If you like this article, please leave a like, thumbs up, or your comments for feedback that will help to further improve our content.