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:
Open-end funds-
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:
o 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.
o Avoid investing in
high sectors or industry bets as they are prone to more risks.
o 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.
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