5 Things Every Investor Should Know About Mutual Funds

Mar 11, 2020 02:31 PM ET
5 Things Every Investor Should Know About Mutual Funds

Mutual Fund is one of the most popular and affordable investment tools for creating capital. Today, investment opportunities are practically unlimited, and a person with any size of money can invest in mutual funds. This short guide will be of interest to those who want to understand how mutual funds organized and what to look for when choosing them. Consider the main types of funds, their classification, and other characteristics.

What is a mutual fund?

A mutual fund is a form of collective investment that allows investors to become the owner of a share of the fund, thereby gaining access to its portfolio of assets. The choice of assets in the portfolio matches the goals and strategy of the fund. For example, for a fund whose purpose is to ensure minimal risk at a given rate of return, fixed-income instruments are suitable. In contrast, any fund that seeks higher returns and long-term capital growth includes more risky assets. And the task of managers is to try to overtake the main stock indexes (S&P 500 or Dow Jones Industrial Average).

Types of funds

There are two main types of mutual funds:

  • Open-end fund
  • Closed-end fund

The Closed-End Fund has a limited number of issued shares (stocks), which became available after its first public offering. They traded on global stock exchanges at a price that may differ from the value of net assets (NAV) per share. The price depends on the ratio of supply and demand in the market and the main indicators of the fund itself.

5 Things Every Investor Should Know About Mutual Funds

Most mutual funds are open. They have no restrictions on the issue of new shares and are available to all investors. An open-mutual fund issues new units based on the current value of net assets (NAV) and redeems the groups that the investor decided to sell.

Legal regulation

Depending on the jurisdiction where the fund is registered and operates, its legal structure depends. As you know, each country has its own rules and regulations for the regulation of investment instruments, and mutual funds are no exception. Rules and regulations prescribe how the fund will control and by which authority, what information managers will have to provide to the regulator, how taxation will be carried out.

Undoubtedly, each fund has its characteristics and differences. Funds can be called differently, have different structures, but in essence, they are all similar and have standard features. Their main task is to raise funds by selling their shares with their subsequent investment in financial assets.

Fund investment models

Perhaps one of the most critical points when considering a mutual fund is the assets in which it invests. In general, the following types of investment objects are distinguished:

Equity. 

It's easy to guess by the name that the funds invested in shares of various companies. Such funds are actively managed and passive. The first type involves the active participation of managing managers in the formation of the portfolio of the fund, and the second type only tracks market indices. The most famous stock index fund is the Vanguard 500 Index Fund. Or one of the varieties is ETFs (funds traded on the exchange), for example, the SPDR S&P 500 ETF.

The investor can choose among a wide variety of funds depending on the region, countries of the world, and currency. For example, if you are interested in shares of companies in emerging markets, you can pay attention to AB Emerging Markets Growth or The VanEck Emerging Markets Fund. If you want to invest in European companies, FT Mutual Europe is right for you.

Fixed Income. 

The fund's investment strategy will depend on its focus. Still, investments may include government, corporate, municipal bonds, as well as other debt securities of individual countries of the world or regions. An example is Morgan Stanley Euro Bond, which invests in European debt securities.

Fixed Income

The Mixed/Asset Allocation. 

To reduce risk by creating a diversified portfolio, the managers of such funds prefer stocks and fixed-income securities, as well as the currency market and other assets. As a rule, in terms of profitability and risk, they occupy an intermediate position between equity and bond funds. An example is the BlackRock Global Allocation Fund. The diagram below indicates that his portfolio includes stocks, bonds, and even currency and commodities.

Commodities/Energy. 

Funds can be invested in commodities, including precious metals, energy resources (oil, gas), as well as in shares of companies that are engaged in the extraction and processing of these resources. For example, the Franklin Natural Resources Fund invests in large energy companies from various countries. The top 10 most companies in the portfolio presented in the table below.

Money Market.

 This tool is considered the lowest risk among all types of funds. The main objective of such a fund is to receive income in the form of interest with minimal risks while maintaining the net asset value.

Property. 

This type of funds should highlight since they have a slightly different structure. However, the essence of this does not change. REIT invests in residential and commercial properties worldwide. The fund's profit is from the rental of real estate or their sale (development funds). REITs provide access to many types of real estate, including residential properties, office space, shopping and entertainment centers, warehouses, and even student dormitories.

Which class to choose?

When studying mutual fund information brochures, you will come across a term such as "share class." There are many different classes of stock funds - "A," "B," "C," "D," "I," "R," "G." It is not the whole list! Of course, diversity greatly complicates the selection process. After all, each fund has its characteristics and is not suitable for everyone.

It should immediately be said that managers call their classes differently. In this regard, the class name does not always comply with generally accepted standards, which you can find in the reference literature. Therefore, we recommend that you carefully study the information brochures of each fund to understand the difference between the unit classes. Most often found are the names "A", "B" and "C".

The classes of mutual fund units may differ in the following characteristics:

  • Fund currency
  • The presence of dividends,
  • Fee structure
  • The cost of one share.

Different classes may provide different commission fees and the procedure for their calculation. For example, one class involves paying a commission when buying shares, the so-called "Front-end load" or "Initial Charge," and another type obliges you to pay a percentage when selling shares ("Back-end load" or "Redemption Fee").

In this case, the investor decides for himself whether it is profitable for him to pay the fee immediately upon purchase or upon sale. Or one of the classes has a "Front-end load" commission that is small, but the annual administrative commission is higher (AMC or Ongoing Charge). We will talk more about commission fees in our next article.

The classes of fund units may have different currencies. For example, one of Luxembourg funds, which specializes in direct equity investments, - Equity Power Fund offers private investors a class of class a shares in euros and class B shares in US dollars. Institutional investors have access to other types of stocks. Accordingly, their price is different. See the table below.

5 Things Every Investor Should Know About Mutual Funds

When purchasing shares, the client can choose whether he wants to receive dividends or reinvest income for the next period. Typically, classes that pay dividends indicate the prefix "In" (Income class), and types that accumulate income you can find the "Acc" (Accumulation class).

Thus, we examined the main types and types of mutual funds depending on legal regulation, investment objects, got acquainted with the main classes of shares. In the next article, we will examine in more detail the features of calculating commission fees and types of commissions, as well as other essential nuances to monitor.


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