What are mutual funds?

A mutual fund is a financial vehicle that creates a pool by collecting money from various investors having a common financial goal. The investments made in mutual funds are usually in stocks, money market instruments, bonds, and other assets. Mutual funds give the benefit to individual investors of getting aid from professional money managers. The portfolio is integrated and managed to meet the investment goal stated in the prospectus.

Every shareholder participates proportionally in profits and losses of the funds as it gives individual investors access to portfolios of securities, equities, bonds, etc.

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The price of a mutual funds’ share is also known as the Net Asset Value (NAV) per share. To derive the NAV of the fund, you must divide the total value of the securities in the portfolio by the total amount of the shares outstanding. The shares held by all the shareholders, institutional investors, company officers and insiders are referred to as outstanding shares. These funds can be redeemed or be purchased as required at the current NAV of the funds. There are several securities in mutual funds that means the shareholders gain significant diversification at a reasonable price.

How do mutual funds work?

The return earned from mutual funds is of three types

1. Income is created from the dividends on stocks and interest on bonds held in the fund’s portfolio. Most of the income received over the year by a fund is paid out in the form of distribution. Investors are offered a choice by funds to either receive the distributions by cheque or reinvest the earnings and buy more shares.
2. If the fund sells securities that have seen an increase in cost, then the fund will earn capital gains. A lot of times, these gains are distributed to the investors by funds.
3. If the fund holdings observe a rise in price but are not sold by the fund manager, the shares of fund increase in price. These mutual funds can then be sold in the market for profit.

Usually, mutual funds are part of a larger investment company, the bigger companies have numerous separate mutual funds.

Types of mutual funds

Depending on the types of securities they have targeted for their portfolios, and the type of returns received, mutual funds get divided into different categories. There is a fund for every type of investor and investment.

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There are other common types of mutual funds that include money market funds, alternative funds, sector funds, target date funds, smart beta funds, and funds of funds or mutual funds that purchase shares of other mutual funds.

Mutual funds fees

Mutual fund expenses get classified as annual operating fees or shareholder fees. An annual percentage of the funds under management is annual fund operating fees. It is also collectively referred to as expense ratio. Investors pay shareholder fees at the time of buying or selling funds. These expenses are usually paid in the form of sales charges, commission, and redemption fees.