What is a mutual fund? — Bizinfuse
learn what mutual funds are, their benefits and fees involved.
Mutual fund definition
A mutual fund can simply be defined as a financial vehicle whose money is pooled from different individuals then invested in a large group of assets. They’re operated and run by professional money managers who are tasked with making sure that the portfolio is profitable.
How does a mutual fund make money?
Mutual funds make money from any of these 3 primary sources:
- Capital gain
Capital gain is basically arrived at whenever mutual funds sell securities that have gone up in price. The gained difference is then distributed to mutual fund investors annually. - Dividend
Mutual funds receive earnings or dividend from investments they make. Much like capital gains, dividend is also distributed to investors. - Net asset value
Compare this to a stock. When the value of a stock goes up, the price to purchase that stock also goes up. Likewise, price to purchase a share goes up as the value of the mutual fund increases. This makes the value of your investment in that particular mutual fund to go up.
Fees to consider when investing in mutual funds
One of the most important thing to consider before investing in a mutual fund apart from performance is fee. Always make an effort to get an overview of the total costs associated with owning, maintaining and managing a mutual fund investment.
- Administrative costs
These are charges that you as the investors pay indirectly for the day to day running expenses of a mutual fund. Such operations may entail: printing costs, record keeping and renting office space just to name a few. Keep in mind that costs could significantly vary depending on the size of the mutual fund. - Expense ratio
A lot of new investors deem expense ratio as inconsequential because of its small percentages. Expense ratio applies to an investor’s total capital and not the profits. It is an annual fee that is calculated by dividing operational expenses by the average dollar value of all assets under management. Make sure to inquire about expense ratio before investing.
- Management fees
Also known as advisory fees, these are charges to us the investors. These fees are used for paying the portfolio manager for making wise investment decisions. Although not charged directly to investors, management fees are attached to the expense ratio. Take it upon yourself to always inquire about it prior to investing. - Sales load
Different share classes determine what is known as load charge. We can define load charge as a fee simply used for compensating intermediaries for distributing shares.
Load can be categorized as: level, front end or back end. Front ends are associated with A- share classes and are charged when investors buy the fund. Back ends on the other hand are linked with B and C share classes. They’re paid when investors sell the fund. - Marketing and advertising fees
These are fees charged to investors that go towards paying for: brochure distribution, marketing costs and advertising. Sometimes they are referred to as 12b-1 fees. Know that for every advertisement you see on TV, print or online, you as the mutual fund investor pay for that.
Benefits of mutual funds
- Diversification lowers risks
- Handled by professional money managers
- They are affordable
- Offer great liquidity
- Commitment free
Conclusion
Mutual funds are a great place for risk averse investors to start. They are well managed and run by professional who understand the markets well. Although they help reduce risks and diversify portfolios, always research and inquire about underlying costs.
