What is a mutual fund anyways an average person may well ask?
A mutual fund is simply a co-operative means by which means many people can pool their savings together and have it professionally managed and as well take advantage of institutional volume discount pricing of purchase and sales commissions.
The concepts of pooling allow investors with relatively small amounts of money to access investments that may require larger sums to achieve affordability.
Government and corporate bonds, for example, require minimums much higher than the $500 or so that most mutual funds will accept as minimum deposits. Additionally, pooling those many small sums gives the fund manager enough capital to broadly diversify the investments within the fund and provide full administrative and accounting services to unitholders.
Every mutual fund is different, not just in its financial objectives but also in the types of investments, it may hold. Whether a fund holds stocks, bonds or a combination of the two will ultimately define the degree of risk associated with each fund.
The differences in the types of securities a fund will hold are determined by the fund’s objectives. For example, if the objective is to provide unitholders with current income, the fund will hold various types of bonds and income financial vehicles. A fund seeking growth may invest in more speculative common stocks. Obviously the latter is much riskier than the former. Generally speaking, the higher the return objective, the higher the risk, and by extension no risk then no reward.
One of the great benefits of mutual funds is that by holding a variety of stocks and bonds, the investor significantly reduces the risk of losing money over a given period of time. An investor who uses all or her or his money to buy a single stock stands a much greater risk of losing money than one who invests in a mutual fund that holds between 20 and 50 different stocks… This is similar to what your grandfather advised you not to hold all of your eggs in one basket. The chances of the 50 stocks losing all of their value are much less than a single company going out of business.
Furthermore, mutual funds offer the expertise of a highly trained, sophisticated money manager and of a team of researchers with much greater access to information than the gingival investor to select, monitor, and sell stocks and other investment vehicles at the most profitable time. Virtually all mutual funds have some degree risk, but it should be noted that even cash investments run the risk of being devalued by inflation and foreign currency exchange fluctuations.
The liquidity that is the ability to buy or sell investments and convert your funds to cash is another advantage that mutual funds have over many investments. Most funds have their shares or units valued on a daily basis. This means that investors can have the convenience of buying or selling shares or units in a fund on any business day without having to wait or seek a specific buyer to take the units off their hands. And a decision for the mutual fund unitholder to sell or redeem units, will not affect the unit value either.
The basic theory of successful investing is of course to buy low and sell high. Mutual funds take it one step further for investors who do not know, and as well do not particularly want to know what to buy and sell by employing professional management as well as volume institutional transaction sales charges to make those decisions on investors’ behalf. Better for the investor to sleep at night soundly.