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Simple Introduction to Mutual Funds

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Simple Introduction to Mutual Funds

With proper diversification in legal investment vehicles, there are high chances that we can build up a nice portfolio even with a small amount in 10 – 25 years. Let’s take a look at Mutual Funds, what are they, the pros and the cons of investing in them

What are they?

Mutual funds are a form of collective investments, using money gathered from many investors (like HYIP you could say, but in legal form) and managed by a team of fund managers who puts them into various forms of instruments like stocks, bonds, equities etc. In some countries like my own, mutual funds is also known as unit trusts.

Mutual funds are open-ended funds. They’re divided equally into units whose price is directly proportionate to fund’s net asset value; meaning there won’t be a limit to the number of shares. The more funds come in, the more new units will be created.

The Advantages

You will be able to reach and invest in emerging countries’ funds like China, Vietnam and India with mutual funds. Some countries do not allow you to directly invest in their own country’s stocks/bonds and other investment vehicles, so buying a mutual fund might be the only permissible way for foreigners to take advantage of the growing opportunities of the countries.

The diversification of the funds also allow investors to minimize its potential downside risk since different mutual funds invests in different basket of financial instruments. Say a young lad who has only $1,000 to spare for investment. If he were to chose to invest in stocks, he might be only be able to afford one counter stock which costs below $1.00, but if he chooses to invest in a mutual fund, his $1,000 might be split into many different types of investment, possibly to take advantage of the possible upside and avoid the ghastly downside if he were to choose in investing in that one particular stock.

It is pretty much affordable as compared to any other financial tools like property, blue chips or stocks.

The Disadvantages

The high amount of fees in investing one. Before the money reaches to buy any of the funds/ stocks/ bonds in the mutual pool, multiple layers of fees from managing your fund (fund manager’s fees, service fees, maintenance, brokerage fees etc) would have erode a huge certain percentage before reaching the meat.

If you leave your money to the fund managers, you’re at the mercy of the professional team which manages each fund. Having professionals in this field doesn’t mean that you’ll never lose money. Investors of mutual funds have no control over what stocks or instruments to buy or sell. Like sitting in the car to let someone else drive, it poses a huge disadvantage of one who understands the market and know how to play with his asset.

As past performance of any financial tools is no guarantee of its future, so is any of the mutual funds that are available. The risk factor is there. Even AAA rating funds from rating agency like Morningstar could just dip and join the myriad of funds that swim in the red.

Types of Fees on Mutual Funds

Here are some of the fees that you should be aware of. (Some of the Managed Accounts dealing with Forex or other investment tools for all that matters uses the same terms for fees as well so this would be something useful)

Like buying stocks you have brokerage fees, trading forex, you’ll deal with pips spread, mutual funds has probably one of the higher fees around as compared.

Sales Charge

Usually this will be the first charge involved and will be deducted from your capital before you get any units from your mutual fund.

Annual Management Fee

Fund managers usually charge fees when they’re looking after your money and deciding what to buy. This fee is deducted on a daily basis and computed into the price of the fund.

These are the two main component fee charges that we’re talking about when your money gets involved with mutual funds. Some of the other fees, depending on the nature of the funds and whether advisory is required are performance fee, maintenance fee and service charge. These costs is technically known as expense ratio.

The higher the expense ratio, the higher returns the fund you invested will have to make before money gets back to your own coffer. Hope this has been helpful.

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