Mutual funds are considered as a well-varied, low-cost, and tax-efficient way to make your money grow. Nowadays, it’s an ideal investment medium for those who don’t have expertise in investing in the stock market. However, despite their comparative simplicity, there are still several things beginners need to know about mutual funds.
Understanding Mutual Funds
Mutual funds are a type of financial investment vehicle made up of a pool of money collected from different investors. The money collected is used to invest in securities like bonds, stocks, and other money market instruments and assets. Mutual funds are handled by professional fund advisers or managers who have the expertise to know where to allocate the funds to produce capital gains or income.
In mutual funds, you’re buying only a part of the portfolio’s value. A share represents investments in many different stocks rather than just one holding. On average, a mutual fund holds over a hundred different securities. With that, your mutual fund gains important diversification at a low-price value.
How to Earn Returns from Mutual Funds
Investors earn money from mutual funds in three ways:
- You earn income from dividends on the stock and interest on bonds. Mutual funds pay out nearly all of the net income it gains over a year in the form of distribution. Fund managers will give you an option to either receive a check for distribution earnings or reinvest your earnings.
- You will have a return when there is an increase in the price of securities or capital gain.
- You earn a return when the fund share price increases and sell your shares for a profit.
Types of Mutual Funds
Mutual funds come in several kinds of categories depending on the type of returns or kinds of securities targeted for the portfolio. Here are the types of mutual funds every beginner should be aware of:
- Equity or Stock Funds – mutual funds are invested principally in stocks. These funds can come in small, mid, or large caps. These are also categorized based on the approach like aggressive growth, income-oriented, and value.
- Fixed-Income Funds – these mutual funds focus on investments that have a set rate of return. Some examples of these funds are government bonds, debt instruments, and corporate bonds.
- Index Funds – the investment strategy used in this type of mutual fund involves a fund manager buying stocks that correspond with a major market index. The advantages of working with this type of mutual fund are it requires less research, and expenses are reduced.
- Income Funds – these funds provide returns on a steady basis as you invest primarily in government and corporate debt and hold these until it matures to provide steady cash flow for the investors.
- Money Market Funds – These funds are usually safe and risk-free as you invest in short-term debt instruments, mostly government treasury bills. Although you won’t get a substantial amount of returns, you won’t have to worry about losing your principal values.
There are still other different types of mutual funds, and you should read on the Top Mutual Funds 2020 to learn more about them.
Advantages of Investing in Mutual Funds
Investing in mutual funds come with several advantages, and these include:
- Reduced Risk
Unlike investing in stocks, working with mutual funds has reduced risk because of the diversity when it comes to where you place your money. In stocks, when the price of the company share falls, your portfolio is automatically affected. Whereas when you only invest only a part of your portfolio in one company, the risk of it affecting your portfolio is very minimal.
- Experts Manage Mutual Funds
Choosing the right stock to invest in is no easy task. By having a fund manager work over your portfolio, you can be sure to know where to place your money to earn higher returns. Understanding the stock market requires critical thinking and time. If you don’t have the energy and time to study stocks, you can let the experts work on it.
Liquidity refers to the ability to convert your assets to cash easily. Mutual funds are called liquid assets because you can get the money from the mutual fund quickly.
- Tax Efficient
Mutual funds are tax-efficient compared to other investment media. A long-term capital gain tax on an equity mutual fund is zero. This means that you won’t have to pay tax when you sell your investment a year after its purchase.
Investing is one way to reach financial success. If you don’t have too much time on your hands to study investing in stocks, mutual funds are the next best option. For beginners, understanding what mutual funds are and how they work is critical. You must discuss everything with your fund manager so they can help answer your questions regarding your portfolio.