A mutual fund is a collective investment, pooling money from thousands of investors to create a portfolio consisting of bonds, stocks, and other securities. This is done in keeping with an agreement enforced by the company offering mutual funds. Each mutual fund investor gets his or her share of returns from the total funds.
Mutual funds allow investors to make investments ranging from a few hundred to thousands of dollars. They also help investors create a diversified portfolio at low costs when compared to purchasing individual bonds and stocks. Also, mutual funds save you the trouble of tracking multiple investments as this is taken care of by the fund manager.
Stock funds are mutual funds that invest in stocks. There are different types of stock funds, such as index funds, growth funds, value funds and hedge funds. Growth funds invest in stocks of fast growing companies while index funds buy and sell securities that reflect a particular market index. Specific stock funds have clearly defined preferences in terms of growth and value. For instance, a stock fund could invest in the securities only from a particular sector or those from several countries. The fund may focus on large cap or small cap companies or stress on current income as opposed to growth.
A wide range of bond funds are also available for investors looking to buy into mutual funds. One such investment includes the U. S. government bond funds issued by the federal government agencies or the U. S. Treasury. With this form of investment, credit-risk related hassles are absent. However, owing to this safety offered by U. S. bond funds, their returns are lower than what you’ll get from other bonds.
There are two types of government bonds – short term and long term bonds. Similar to all other bonds, even government bonds tend to experience fluctuations. So short term bonds are ideal for those who don’t want to deal with fluctuating markets in the long run. Other types of bond funds invest in high yield bonds, corporate bonds, municipal bonds etc.
What to Keep in Mind when Investing in Mutual Funds
When you decide to invest in mutual funds, consider the risks involved. To understand risks, you need to assess three key aspects. Firstly, what kind of returns has the fund given in the last 3-5 year period? Secondly, what is its beta – which is a measure of the fund’s sensitivity relative to the broad market. A higher beta means the fund is riskier. Lastly, look at the standard deviation in the fund’s returns, which gives an estimate of the fund’s tendency to stray from its average returns.