Mutual Fund Investment Advice

Understanding Mutual Funds

A mutual fund issues shares to investors, pools together their money and invests the pooled money in stocks, bonds and other securities. Investing in a mutual fund is advantageous to an individual who lacks experience in the realm of investment. The fund's investment advisors, who are registered with the SEC, are supposed to have expertise in selecting securities. Hence, they can be relied upon to diversify and choose investments with the potential for capital appreciation or capital preservation, in accordance with the fund's mandate. Selling securities, that have appreciated in value, will result in capital gains to the fund. If the fund does not unload the appreciated securities, the price of the fund holdings will increase. A mutual fund has a great deal of liquidity and an investor can always sell fund holdings that have appreciated in value. In addition to possible capital gains, the investor may receive interest and dividend income, from investments, in the form of cash or additional mutual fund shares.

Mutual Fund Investment Advice for Beginners

Types of Mutual Funds: A beginner would do well to explore money market mutual funds, that invest in short term debt instruments, like Treasury bills issued by the US govt. The bills, that are sold at a discount to par, have a maturity period of less than one year. They provide returns to the investor by appreciating to their par value. Equity funds and Bond funds invest in stocks and bonds respectively. While capital preservation with a steady income is the objective of the former, the latter generally focuses on capital appreciation. A fund, that invests in a combination of bonds and stocks, is known as a balanced fund. Index funds owe their popularity to the proponents of the Efficient Market Hypotheses who believe that it is impossible to beat the market since market efficiency guarantees the incorporation of relevant information into the price of securities. Hence, investing in an index fund, which in turn mirrors the performance of an index (like S&P 500), may be the best investment strategy. Global funds provide the benefit of international diversification but they may be risky since it is relatively difficult to assess the political and economic stability of international markets.

Mutual Fund Investment Advice: Net asset value or NAV is the difference between the fund's assets and it's liabilities. This is divided by the number of outstanding shares to arrive at the NAV of one share. The NAV of the shares fluctuates on a daily basis. An individual who is interested in investing in a mutual fund can do so by paying an amount, that is equal to the NAV of a share times the number of shares, provided the fund sells shares without charging a commission. Funds that do not require the investor to compensate the brokers / salespeople, by paying a commission for mutual fund shares, are known as no-load funds. Funds may either have a front-end load or a back-end load. Front-end load refer to commissions paid on buying shares while back-end load refers to commissions paid on selling shares of the mutual fund. While back-end load funds reduce capital gains, front-end load funds reduce the amount of initial investment. Hence, a no-load fund is the best investment. Mutual fund shares can be bought (and sold) from the fund, or from a broker or from the secondary market. One can choose to redeem the shares by selling the shares back to the fund.

The investor cannot control the selection of securities by the fund manager. Moreover, an investor is expected to pay management fees, administrative fees and promotional expenses regardless of the performance of the fund. These costs tend to significantly lower the returns on investment.

Ultimately, the performance of mutual funds is contingent to the ability of the fund manager to select securities with a potential for capital appreciation or at least capital preservation. One needs to note that past performance of the fund is not indicative of future results. Moreover, mutual funds are not guaranteed or insured by FDIC (Federal Deposit Insurance Corporation). Hence, the investor is susceptible to loss in case the fund manager lacks the required expertise.