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What are Mutual Funds? | Understanding the Basics


April 9, 2020
What are Mutual Funds? | Understanding the Basics

A mutual fund is a form of investment that pools money from multiple investors in order to purchase a portfolio of securities, such as bonds and stocks. The mutual meaning of these funds is linked to having various investors who are interested in the same type of investment.

For decades, the mutual fund industry has evolved into one of the most attractive spots for investors across the globe. The increased popularity of mutual funds is often attributed to the level of diversification, customizability, liquidity, and professional management that they offer. Today, over £20 trillion worth industry is one of the essential tools used by investors to save for retirement and grow wealth.

Whether you are a beginner or an experienced investor, understanding the basics of mutual funds is fundamental to the success of your investment. This article provides a guide into everything you need to know about mutual funds and how to invest in the best mutual fund.

Definitions – What is a Mutual Fund?

Mutual funds should not be confused with mutual loans. While a mutual loan refers to a type of credit issued and received by the same people, a mutual fund is for investors with common investment interests.

mutual funds

How Do Mutual Funds Work?

Mutual funds are left in the hands of professional portfolio managers whose mandate is to handle and oversee the funds. Investors whose money has been pooled together become shareholders to a mutual fund share. Profits or losses generated by investments made using the fund are divided amongst the shareholders. It is essential to know that, just like any other form of trading, the best investment funds can also result in losses.

The management of mutual funds varies depending on the approach used.

  1. Passively managed funds. The investment is made based on set goals and strategies. Their target is to match certain market indices.
  2. Actively managed funds. The objective of such funds is to outperform certain market indices.

Benefits of Mutual Funds Investment

Individuals who invest in mutual funds enjoy plenty of benefits, including the following.

  • Diversification

Diversification is one of the essential strategies of any investment. Investing all your money in a single market puts you at risk of losing the money, should there be an economic crisis or downturn.

With a portfolio of securities, however, the risk experienced by one security is cushioned by the gains of the other within the same period. The advantage of investing in a mutual fund is that you enjoy a diversified portfolio without having to buy multiple securities by yourself.

  • Professionalism

Mutual funds are managed by professional managers who are responsible for the purchase and sale of securities within that fund. The benefit that comes with such professionalism is that the decisions made by these managers are aimed at gaining the highest returns with low risks.

  • Affordability

Investing in mutual funds usually demands very little minimum deposits, from as low as £500 to £5,000. In some instances, these minimums are waivered by brokers on the requirement that you make direct deposits to purchase fund shares per month.

  • Ease of Liquidation

Mutual funds are easy to liquidate compared to other personal assets.

Types of Mutual Funds

invest in bonds

Choosing the best performing funds is influenced by various factors, including the type of fund. Here is a highlight of the various types of mutual funds.

  1. Money Market Funds

These funds carry the lowest returns as they bear the lowest risks. These funds are invested in short-term investments of high quality, typically issued by corporations and governments.

  1. Balanced Funds

These are funds that are invested in a mix of securities, including cash, fixed-income assets, and stocks. They are also known as hybrid or asset allocation funds. An example of balanced funds is the Standard Life Managed Pension Fund.

  1. Bond Funds

These are mutual funds that are invested in the various types of bonds. They are less risky compared to stock funds.

  1. Stock Funds

These funds bear the largest potential returns. This is why they come with very high risks. Stock funds refer to funds that are invested in the various types of stocks.

How to Invest in Mutual Funds

FTSE 100 Market Shares

There are various ways through which investors can make money from a mutual fund. Here is an outline of how to invest in mutual funds the UK.

  • Capital Gain

This refers to profits generated from the sale of a security held in a fund after its price has gone up.

  • Dividend Payments

This is the proportional amount issued to investors after security held in a fund has generated interest or dividends.

Best Performing Funds 2019

If you are looking for the best investment trusts or funds that performed best in 2019 across the globe, here is an outline:

  1. Fund smith Equity
  2. Vanguard Life Strategy
  3. Lindsell Train Global Equity
  4. HSBC FTSE 250 Index C
  5. Vanguard Funds
  6. Franklin UK Mid Cap
  7. Premier UK Growth
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