Mutual Fund: Types & Functions

What do you mean by Mutual Fund?

What are its major characteristics?

What are the major types of MF?

What are the advantages and disadvantages of MF?

Mutual Fund:

A mutual fund is a type of Investment Company that pools money from many investors and invests the money in stocks, bonds, money-market instruments, other securities, or even cash. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Major Characteristics: 

• Investors purchase shares in the mutual fund from the fund itself, or through a broker for the fund, and cannot purchase the shares from other investors on a secondary market.
• Mutual fund shares are "redeemable." This means that when mutual fund investors want to sell their fund shares, they sell them back to the fund, or to a broker acting for the fund.
• Mutual funds generally sell their shares on a continuous basis, although some funds will stop selling when, for example, they reach a certain level of assets under management.
• The investment portfolios of mutual funds typically are managed by separate entities known as "investment advisers" that are registered with the SEC. In addition, mutual funds themselves are registered with the SEC and subject to SEC regulation.

 

Types of Mutual Fund:

Mutual funds can generally be placed into one of three primary categories: stock, bond or money market. Many investors will diversify their portfolio by including a mix of the three.

1.    Stock Funds

Stock funds, also called equity funds, are the most volatile of the three, with their value sometimes rising and falling sharply over a short period. But historically stocks have performed better over the long term than other types of investments. That’s because stocks are traded on the expectation that a company’s future results will include expanded market share, greater revenues and higher profits. All of that would increase shareholder value. Not all stock funds are the same. Some common funds include:

• Growth funds, which offer the potential for large capital appreciation but may not pay a regular dividend.
• Income funds that invest in stocks that pay regular dividends.
• Index funds, which try to mirror the performance of a particular market index, such as the S&P 500 Composite Stock Price Index..
• Sector funds usually specialize in a particular industry segment, such as finance, health care or technology

2.   Bond Funds

Bond funds, also known as fixed income, invest in corporate and government debt with the purpose of providing income through dividend payments. Bond funds are often included in a portfolio to boost an investor’s total return, by providing steady income when stock funds lose value. Though usually safer than stock funds, bond funds face their own risks including:

• The possibility that the issuer of the bonds, such as companies or municipalities, may fail to pay back their debts.
• The chance that interest rates will rise, which causes the value of the bonds to decline
• The possibility that a bond will be paid off early. When that happens within bond funds there is the chance the manager may not be able to reinvest the proceeds in something else that pays as high a return.

3.    Money Market Funds

Money market funds have relatively low risks, compared to other mutual funds and most other investments. By law, they are limited to investing only in specific high-quality, short-term investments issued by the government, corporations, and state and local governments. Historically the returns for money market funds have been lower than for either bond or stock funds, leaving them vulnerable to rising inflation.

 

Advantages and Disadvantages of MF: 

One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund. Other advantages are:

o    Increased diversification; When you purchase shares in a mutual fund, your dollars are invested in a large number of companies all at once, and your investment risk is spread out over many stocks of many companies, not just one. With mutual funds, your potential for risk is less. The ups and downs in the value of your investment are potentially less with a mutual fund than with an individual stock because you are more diversified.

o    Professional investment managers also known as mutual fund managers look after the stock portfolio of a Mutual Fund. Unseasoned investors or those with less time can benefit from the expertise of the mutual fund manager.

o    Ability to participate in investments that may be available only to larger investors

o    Mutual fund shareholders can invest even small amounts and get a share in a valuable stock portfolio. Monthly payment programs are also offered by many mutual funds

o    A mutual fund tries hard to maintain certain level of returns for its shareholders. The mutual fund NAV (Net Asset Value) is a key index of a mutual fund. Mutual fund managers endeavor to maintain optimal NAV levels during good times and bad.

o    Daily liquidity

o    Service and convenience

o    Government oversight

o    Ease of comparison

Mutual funds have disadvantages as well, which include:

o    Fees

o    Less control over timing of recognition of gains

o    Less predictable income

o    No opportunity to customize