E Finance Blog

Mutual Funds and their Importance

October 1st, 2012 by editor

A mutual fund is a pool of money collected from several investors and invested by an Asset Management Company (AMC) in various stocks, bonds and other types of financial securities, as per the objectives of the investors or the mutual fund scheme. Here, many investors combine their resources and use the contributions to invest in a wide variety of financial instruments.

The mutual fund generally is managed by a fund manager who allocates the funds in different investments to meet the objectives of the scheme, and the returns on the investment are distributed among the fund members as per the units held by them.

The mutual fund managers invest in safe as well as high-risk securities depending upon the risk taking capacity and return expectations of the investors.

Why mutual funds are a popular investment option

One of the biggest advantage of mutual funds is that it allows small investors to invest and take guidance from professional fund managers to maximize their returns. Here, a single individual is not investing, but the investment is in a collective form that increases the overall buying power of all the investors. Thus, even if you have a limited amount of money, the mutual fund allows you greater opportunity to get good returns on your funds over a period of time. This would not be possible if you consider the option of investing in shares individually. With limited amount of money, small investors can look forward to investing in various types of securities and growing their wealth.

In addition to a good growth potential, mutual funds also tend to diversify your investment portfolio and thus minimize or balance the risk and volatility associated with the investments made by the fund manager. Each mutual fund investor shares a certain amount of risk based on their contribution to the fund.

Mutual fund applications

Retirement planning is one of the most common applications of mutual funds. Pension plans as well as individual 401 (k) plans make use of mutual fund schemes to grow the contribution from the members. One can also earn money by investing the contributions from Individual Retirement Accounts in mutual funds. This is applicable for both traditional as well as Roth IRA.

Whenever you are investing, it is important to accurately predict the market movement and execute the trade at the correct time. Since a professional fund manager handles the investments of the mutual fund scheme, it is easier for the investors to get maximum return on their investments as the fund managers track the market on a daily basis and very experienced in the field of managing money.

Advantages of investing in mutual funds

Professional Management: When you invest in a mutual fund, you can leave all your worries to the professional fund manager who manages the mutual fund on your behalf. The fund managers or money managers are well trained to track the daily market movements and are capable of investing in the right financial securities to balance the risk and generate good returns. The fund managers carry out research on the different securities and know the exact time when to buy or sell a security to get the maximum benefit.

Diversification: A single investor cannot buy a huge number of securities in comparison to what he can buy by investing in a mutual fund. A single mutual fund scheme can hold a large number of securities from various issuers. Diversification is the process of mixing of different investments in a given portfolio in order to manage the risk. As all the eggs are not placed in one basket, it tends to reduce the risk of a major loss even if one company does not perform well.

Economies of scale: As a number of investors are involved in a mutual fund, they can take the advantage of the buying as well as selling size to minimize the transaction costs. This is possible while dealing with stocks where in you would have to pay a lot of commission charges as well as transaction fees every time you wanted any change in your portfolio. However, a mutual fund provides economies of scale and you are able to diversify with minimal costs.

Liquidity: In case of mutual funds, it’s relatively easy to get in and out of the scheme as per your need. You can sell the mutual funds within a short span of time when there is not much difference in the sale price of the mutual fund and it’s market value at the time of sale. You need to, however, take care of any charges or fees involved while selling such back end load fees.

Convenience: With mutual funds, your investments become easier to manage. You can buy or sell the fund shares over the telephone, via mail or the Internet. It is quite simple and quick to move your money from one fund to the other as per your financial needs. You can also make arrangements to transfer money automatically from your fund to the bank account and vice versa. Most mutual fund companies also maintain accurate records for your convenience so that you can file your tax returns and stay updated with the fund’s performance.

Posted in Personal Finance category.