Mutual Funds

Abstract

J. Paul Getty says: "Money is like manure. You have to spread it around or it smells." Investment can be risky and tricky. However, that’s the smart way to make your money work for you. There are thousand ways to spread your money, yet mutual fund is a safe and least expensive way to invest. Like other investments, they have advantages and disadvantages. That’s why we always need to learn and understand them in order to decrease the risk, yet at the same time, increase the reward. If your learn how to use them correctly, mutual funds will become your outstanding money tree. Investing in mutual funds require patience and confidence, just like real estate. You put an amount of money into a house or funds, then the price goes down and you get nervous. You sell them after only three or four years, when you have not made anything out of them yet. The key to succeed here is to do your research and believe in yourself. This research will give you a simple and clear overview about mutual funds and help you understand the basic way in which they work.


Keywords: mutual funds, succeed, investments.

What is a Mutual Fund?

A mutual fund is a pool of money from investors. A fund manager invests this pool of money in stocks and bonds market in order to meet a specific investment objective. The fund manager can be an investment company which handles various investments including stocks, bonds and money markets. For investors with limited time, expertise, or experience, mutual funds offer the perfect choice of investments at a very low cost. Each mutual fund is managed by a professional money manager who will decide where your money will go. The mutual funds investors will agree on sharing the brokerage expenses, management fees, and other operating costs incurred by the fund. Mutual funds have existed for more than 80 years and become the most common investment for average Americans.

The advantages of Mutual Funds 

Instant diversification:


If you have a little money to invest, the money will not buy many shares of single stock in the market. You also need to buy two or three different stocks to reduce the risk of losing all your money if they plummet in price. By pooling money together in mutual funds, shareholders can instantly diversify their investment without the large cost to create individual portfolios. According to Jordan E. Goodman, “If two or three stocks in the portfolios get hit hard, your losses will be much more limited because the value of many of the other stocks will probably be holding their own or going up at the same time.” (2002, p.90)


Professional management:


Professional managers use their skills and expertise to handles shareholder’s money. They have an open access to extensive company research and market information. Not every investor can have time and full knowledge to manage the personal investments at a reasonable cost like having a professional manager.


Save money and time:


With regard to the two advantages mentioned above, we can clearly see how mutual funds can save you money and time. If you are a regular full-time employee and want to earn money without taking up investing seriously, this will be the best way. In addition to this, it doesn't cost much to start your investment. One to two hundred dollars is enough to purchase smaller mutual funds. (“The advantages of mutual funds”, 2012)


Choose your risk level:


There are many choices of funds that you can match with your financial goal, time horizon and your risk tolerance. According to Infoplease.com, there are three basic kinds of funds:


Money market funds: Considered the lowest risk, they are limited by law to certain high-quality, short-term investments. Investors rarely lose money on these funds, but it's possible.


Bond funds: These have a higher risk than money market funds, but pay higher yields as well. Most bond funds also have a credit risk. “If you want safe investments, consider government bond funds; if you're willing to gamble on high-risk investments, try high-yield bond funds; and if you want to keep down your tax bill, try municipal bond funds." (Basics of investing in mutual funds, para.6)


Stock funds: These offer the highest returns, but involve more risk than other funds. A stock fund's value can rise and fall quickly in a period of time but generally a stock fund's performance over long-term is better than the other funds.


Easy access to funds:


You can get in and out with mutual funds easily. With just a phone call or few clicks of the mouse, you can buy and sell funds quickly. This instant liquidity can be a big advantage. By law, the funds have to allow you to redeem your shares at the current NAV. Therefore, you can participate anytime in the market if you suddenly see the chance of earning profit. On the other hand, you can easily sell a handful of shares if you know it will be difficult to get a decent price in the near future.

The disadvantages of Mutual Funds 

Taxes


Taxes are the biggest disadvantage of mutual funds. With an individual stock, you don't have to pay taxes as long as it sits on your portfolio. However, with mutual funds, you will receive a taxable distribution, even if you never sell a share or reinvest your gain. Your mutual funds are required either pass out all their gains each year, or pay corporate income tax on them. When you get a distribution, the taxes become yours.


Lack of control


Having a professional manager is an advantage of mutual fund, on the other hand, also becomes a weakness. The fund manager makes all the decisions on buying and selling stocks without your opinions. In additional, you cannot ascertain the exact make-up of a fund's portfolios.


Annual fees


“Mutual funds charge an annual fee of about 1 to 2 percent of your total invested assets every year whether you make new investments or not”.(Jordan E. Goodman, page 92). These costs and taxes can be a big bite of the total profit earn by mutual fund shareholders.


Performance:


During the high-tech crash of the 1999-2002, millions of mutual funds investors lost a lot of money because their professional managers had invested a large amount of money in technology and Internet stocks (Goodman, 2002, p.92). The historical performance of the funds sometimes do not show the true value of the funds. It easily guide investors, even the professional investment specialists, down the wrong path.

Keys to succeed with Mutual Funds

The magic money-making part in mutual funds is compounding. Compounding is the ability of assets to generate their own earnings. It means you can make interest from the performance gains plus any dividends and reinvested capital. The longer you invest, the more powerful compounding gets. When you invest in mutual funds, it takes longer to get the same profit that you do with the other types of investments. You need to be careful when selecting your fund, and stick with your choice over time. Based on the example in the book How to make money in stocks (William J. O’Neil, 2002, p.237), if you purchase $10,000 of a growth-stock fund that averages about 15% a year over a period of 35 years, here is how compounding might occur:


First five years $10,000 becomes $20,000


Next five years $20,000 becomes $40,000


Next five years 40,000 becomes $80,000


…....


At the 35th year 640,000 becomes 1.28 million!

As you can see, compounding interest is the way to make money work for you, instead of you working for it. So the key here is a good starting choice and to stick with it. To achieve success, you need to do your homework! Do some careful research before you decide to invest your money into any kind of fund, and stay with it long-term. Nothing is guaranteed, however the example above could happen to you if you plan and invest in mutual funds correctly. Trust in yourself and be patient. Even though the market will be up and down and the economy may go into a recession, don't be nervous. Instead, try to look ahead several years. After raining, the sky will be brighter. Like William J. O'Neil said: “Buy right and sit tight!”

References

ABC's of Mutual Funds | Infoplease.com. (n.d.). Infoplease: Encyclopedia, Almanac, Atlas, Biographies, Dictionary, Thesaurus. Free online reference, research & homework help. | Infoplease.com. Retrieved July 4, 2013, from http://www.infoplease.com/ipa/A0001495.html


Basics of investing in mutual funds. (n.d.). CNN Money. Retrieved July 4, 2013, fromhttp://money.cnn.com/magazines/moneymag/money101/lesson6/index.htm


Goodman, J. E. (2002). Everyone's money book. Amherst Enterprises Ltd.


Hirschey, M., &Nofsinger, J. (2010).Investments analysis and behavior. (2nd ed., p. 701). New York: McGraw-Hill,Inc.


Investopedia. (2012, March 13). The Advantages Of Mutual Funds. Investopedia - Educating the world about finance. Retrieved July 4, 2013, from http://www.investopedia.com/articles/basics/03/040403.asp


O'Neil, W. J. (2002). How to make money in stocks. (3rd ed.). New York: McGraw-Hill,Inc.