mutual funds

How Do Mutual Funds Work?

A mutual fund is a form of investment that consists of a variety of different forms of investments like stocks, bonds, and government securities.

A mutual fund company pools your money along with the money of other investors to invest in the portfolio of investments.

This enables you to invest in portfolios you may not be able to invest in alone.

Mutual funds include different types of stocks that help in mitigating the risk involved from the rise and fall of the share price.

With the diversification of various stocks that may be included in the portfolio, the risk involved in a particular type of share gets mitigated by another.

There are many funds available, however, Vanguard funds are highly recommended by many financial advisors.

The Various Ways In Which You Gain From Investing In Mutual Funds

Here is how you should invest in mutual funds and gain benefit from them:

  • Power of compounding
    Mutual funds enjoy the power of compounding. Investing in mutual funds will allow you to earn interest on interest too.
    These compounding benefits increase the value of your investment particularly if you invest in them for a long period.

  • Diversification
    As mentioned earlier, mutual funds, being a pool of different types of securities, enjoy the benefit of diversification which reduces the overall risk associated with investing.
    Not all types of stocks rise and fall at the same time. So, the losses from one type of stock can be canceled by the gains from other types of stocks.

  • Capital gain distributions
    By selling a mutual fund at a high price, you get a capital gain and vice versa.
    One can further invest the capital gains in buying mutual funds too.

  • Distributions
    There are various other forms of gains you receive depending on the type of mutual fund you invest in.
    It could be from dividends, interests, capital gains, or some other income. This gain can either be received in cash by the investor or be reinvested in mutual funds again.
    Mutual funds dividends are not taxed. However, mutual funds are taxed for distributing dividends. This is applicable not on equity mutual funds but debt mutual funds.

  • Transparency
    As mutual funds are closely regulated by the involved authorities, mutual funds are safe to invest.
    You can also track all your mutual fund investments at any time of the day. Moreover, you can also take the help of asset management companies to regularly deliver updates on how mutual funds are faring.

  • High liquidity
    Open-ended mutual funds allow investors to withdraw their money at any time at the prevailing Net Asset Value (NAV) of the investment.
    This prevents your money from getting locked in.

The types of Mutual Funds

There are multiple types of mutual funds one can invest in according to their needs and preferences.

The three major types of mutual funds are:

  • Equity funds
    Equity mutual funds only involve common stocks that help in earning more money at high risk.

  • Fixed income funds
    Fixed-income mutual funds, as the name suggests, provide low but guaranteed returns as they involve low risk.
    These include investments in government and corporate securities.

  • Balanced funds
    Balanced funds include both stocks and bonds and keep the risk and return balance.
    If you are a risk-averse investor, investing in balanced funds is a good decision.

Do Mutual Funds Work Without A Fee?

Mutual funds may or may not involve fees. Referred to as a load, these are sales charges that an investor pays on purchasing a mutual fund.

This load charge is a sort of commission paid to the fund salesperson that helps you in getting the best return. There are two types of mutual funds in this respect, front end load and back end load.

In front end load mutual funds, the charge is paid as you buy the mutual fund. In the back end load, the charge is paid when you sell the mutual fund.

The load charges can go up to 8.5% of the selling price of the mutual fund. There are no-load mutual funds too in which you don’t have to pay any extra fee provided these are to be dealt with without the help of a salesperson.

If you are a pro-investor, no-load mutual funds are the best option. Moreover, with ample information available on the internet, it is easier to take wise financing decisions yourself too.

Also, there are low load funds too which charge up to 3.5 % of the selling price and can be a good option too if you are new to mutual fund investments.