Before you actually dive into the pool of mutual funds, it is important to have a basic understanding about how they work. Also, you must be well-acquainted with certain terminologies, such as ‘open-ended’, ‘close ended funds’, ‘load’ and ‘no-load’ funds and various other types of funds.
Let’s start by getting to know what mutual funds actually are.
A mutual fund is a pond of money offered by individual investors, organisations and other companies. A fund manager is appointed to make investments on your behalf and the goal of the manager depends on the type of your fund.
For instance, if you make a fixed income investment the manager will make moves to maximise your profits with minimum risk.
What are close-ended and open-ended funds?
Mutual funds are broadly divided into four categories which are described below:
Most people opt for mutual funds which are open-ended. Open-ended funds do not have a specific number of shares. The fund will issue new shares to the investor depending upon the current net asset value and en-cash the shares when the investor plans to sell them.
Open-end funds resemble the net asset value of the fund’s basic investment because the status of shares fluctuates as they are created and destroyed.
Close- end funds-
When a company offers a specific number of shares to the public it is known as close-end funds. This is usually experienced during the initial phase when the company issues shares to the public. An investor has to trade in the open market and transactions of these shares differ from other mutual funds.
They mainly are based supply and demand. One can say that closed- end shares trade at discount to net asset value.
Load v/s No-load-
A load is a term that mutual funds professionals used to refer sales commission. The investor is responsible to pay the sales commission on the net asset value of the share only if the fund charges a load.
On the other hand, no-load funds yield higher profits as the investor is not entitled to pay any commission fees. This means there are no additional expenses linked to their ownership.
Apart from this, did you know that mutual funds have a structure? If no, here’s what you should know about it.
Structure of Mutual Funds
A friend of mine recently invested in mutual funds. She advised that it is important to research prominent financial institutions which offer this service and understand their method of operation.
There are several alterations in how the funds are structured as some institutions work on them on a daily basis. Therefore, it is essential to know the process before you dive into the pool of mutual funds. A good understanding helps you to invest in the right place and reduces the overall risk factor.
You probably will not end up applying for PPI reclaim for a mis-sold policy in the future. Although, there are good dependable companies, which can help you acquire your hard earned money but why invest at the wrong spot in the first place.
Be a wise investor! For this you need to have deep understanding of the field and a background check is a good place to start.
Conduct a Background Check
One attribute of mutual funds that stands out from other types of investments is that it provides every individual the liberty to create their own diverse portfolio. Your portfolio can include bonds, stocks and securities.
They have provisions for small and temporary savings that yield good returns. This diverse opportunity has directed an increasing number of investors in mutual funds. The next step is to know how they work.
Mutual Fund Process Works
Imagine you plan to invest £ 10,000 in ABC Fund. The first step is to open a fresh account at a financial institution offering this service. You can do it online as well as by manually visiting the firm.
This might take few days but once your account is opened here’s the general process that follows:
Your cheque (the money invested) gets transferred to a particular agent. Thereupon you are issued shares of the mutual fund depending on the amount invested.
The amount invested is visible to the portfolio manager and they invest in additional stocks, bonds according to the available funds. They keep a constant check on the net available balance and then invest in and out of funds.
When the portfolio manager plans to buy a particular stock, the manager informs the trading team about the same. The trading team streamlines one source that offers them the lowest available price for that stock in the market.
Once the trade is finalised, the mutual fund will take out the required amount from your account and transfer to the company who sold their stock. Thereupon the shares are transferred to you physically or electronically.
When the stock company pays dividend, you are entitled to receive this amount, which is transferred to your mutual fund account.
Your mutual fund company will en-cash the amount to pay you as a dividend towards the end of the year.
This is the basic process of how mutual funds work but there are certain changes in the process depending upon the firm and your investment.
If you are investing on your own, how do you determine which shares you should target?
Picking lucrative mutual funds
· Invest in No-load mutual funds
If you invest in load mutual funds you are liable to pay 5% of the asset value to the company. If you are putting up a portfolio then it is wise to invest in no-load funds as you get an opportunity to earn better.
· Look for professionals
With digitisation, gaining information has become very quick and smooth. You can easily gain information about whom you are working with or plan to. Here, you need to obtain relevant information about the portfolio manager you plan to work with.
This will ensure that you are with an industry expert and there are fewer chances of making a mistake. Besides, your investments are in safe hands and they would be rightfully invested with good returns.
You can also skim through the manager’s work history and become familiar with a few of the clients they have worked for in the past. It is equally important to determine the effect of their investments before making your decision.
· Philosophy that goes with your choices
Every asset has its own intrinsic value which is referred as the true value. You can say that ‘true value’ is the cash that asset would generate for the owner. It is sensible to invest in assets which offer you good intrinsic value. This ensures that you do not invest in only those assets that would provide you with positive outcomes.
· Diversification of assets
As it is rightly said that, ‘Do not put all your eggs in one basket’ likewise it is wise to diversify your assets. Firstly, putting them in one place can be risky because you could end up losing all your money at once. Then how should you diversify your assets?
Following are some guidelines which can help you do so:
- Avoid keeping all your funds within the same parent fund company. Trace the mutual fund scandal in the past and learn from their mistakes. If you spread your assets in different companies then you reduce risks and unethical activities involved in your investment.
- Avoid investing in high sectors or industry bets as they are prone to more risks.
- Stocks are not the only mutual funds. There are international funds, real estate funds, convertible funds and fixed income funds in which you can invest. The best combination of investment for mutual funds is a domestic equity for a long period of time.