For those who have heard the term “mutual fund” but, like many others, do not understand what they are, the following answers to ten of the most frequently asked questions about these funds may provide some insight.
1. What is a mutual fund?
A mutual fund is an investment vehicle put together by a financial institution, which allows a group of investors to pool their money together with the intention of benefitting from the funds ability to spread these monies over a wide range of investment opportunities. Usually there is a specific strategy involved. For example a fund could be set up to invest in Far East markets or a range of domestic shares. The fund has a manager who task it is to ensure that the investments bring benefit to those investors.
2. How do I earn from mutual funds
You will earn from a mutual fund in much the same way as you do from an ordinary share investment. This will be through ordinary income and capital gains. Each time one of the companies the fund invests in distributes a dividend, your share of that fund will be credited with the appropriate proportion of that income. Similarly, if the fund sells shares that it holds at a profit, you will receive a proportion of that gain.
3. Why should I invest in a mutual fund?
There are two main benefits to investing in a mutual fund. Firstly, they are professionally managed. This is especially important for novice investors or those seeking to invest in markets where they have no expertise or knowledge.
Secondly, because of the size of the fund, the manager is able to diversify the investment portfolio. This act limits the impact of a loss suffered by a particular corporation or industry sector. Thus the fund has the benefit of spreading the risk for the investor.
4. Are mutual funds safer than ordinary share investment?
Like share, the value of mutual funds can go down as well as up. However, although they have risks attached to them, because of the two reasons given in answer to question three above, a mutual fund can be considered to attract a lower degree of risk than a direct investment in a share. To this extent they can be considered safer.
5. Is there a minimum level of investment?
Yes is the simple answer. Most funds of this nature have a minimum entry level, which can vary between $500 and $1000 dependent upon the individual fund.
6. What choices are there in mutual funds?
There are an enormous range of mutual funds, some which are general stock market investment vehicles and others that are more specialized. For example, recently there has been a growth of “green” mutual finds, which concentrate their investments in organizations that are environmentally friendly. Others may concentrate upon specific geographical areas such as the Far East mentioned earlier.
7. Are there any disadvantages to mutual funds?
It depends upon ones viewpoint. The fact that the individual investor has no control over the organizations the fund invests their money in can be classed as a disadvantage. Similarly these funds will make charges to cover their own running costs and expenses, and of course make themselves a profit. These are passed on to the fund shareholder.
8. How much does it cost to invest in a fund?
As mentioned in 7 above mutual funds do charge. Usually their charges will be stated as a percentage of the investors’ particular shareholding and this can vary between 1 and 3%. In addition, some funds will charge an initial set-up and management fee. It is important to find out about the charges before you make such an investment.
9. Are there guarantees of a fund performance?
No. Despite the fact mutual funds can be considered safer that other investments, this does not indicate their performance is in any way guaranteed. Although in the prospectus the fund operator may provide information about past performance, it should also contain a note stating that this does not guarantee the way the fund will perform in the future.
10. How do mutual funds affect my tax situation?
As all gains and dividends from mutual funds are passed to investors, the fund itself has certain IRS tax benefits. However, as is the case with any other stock market investment, for the investor the dividends and capital gains receivable will be taxable and should form part of the tax return information you file annually with the tax authorities.