The partner and I have been invested in mutual funds for a little over a year now and it may be safe to say that we already have some knowledge about it enough to share it to other people.
For readers (and friends!) who would like to have a brief introduction with this type of investment, read on. I hope this can clarify at least a bit of your questions regarding mutual funds.
What are mutual funds?
As the illustration above suggests, mutual funds is a type of investment where investors pool their money together to create a large fund. This fund is then invested into different types of securities (stocks, bonds, deposits and many others) so that it can generate returns. The returns can come from interest from borrowing (such as in bonds) or from company growth and dividends (such as in stocks). A portion of the returns are then given back (after management fees and taxes) to the investors which they can choose to withdraw and spend or invest back into the fund.
Where are mutual funds invested?
Where mutual funds are invested would depend on the type of fund. Generally, the aggressive funds are mostly invested in the stock market where there is a high risk (of loss) but also a high potential of big returns. Conservative funds are concerned with capital preservation and are therefore invested in low risk securities such as bonds, treasury bills, deposit accounts such as time deposits and money market funds. The only downside is that they offer very low returns when compared to stocks. Balanced funds are a combination of the two.
Why choose mutual funds?
Mutual funds are often chosen by people who do not wish to learn the art of stock trading or do not have the time to do so. Since mutual funds are managed by a fund manager whose sole job is to study the market and analyze where to put the money in so that it could generate the highest returns at the lowest possible risk, the only thing that an investor has to do is put money into the fund and wait out for the results. The only downside to investing in mutual funds is that management and other similar fees are incurred.
Which mutual fund should I choose?
There are many factors to determine which type of mutual fund to invest on. For example, you may have to be assessed on whether you are an aggressive or a conservative investor or somewhere in between. This can be determined by learning your risk appetite (how much risk can you take? 10% loss? 20%?). One’s investment horizon (or the time you can do without having the money you are planning to invest in your hands) is also a key factor. It may be that you only allow your money a year or three or five before you use it for something else.
Also, young people are generally recommended to become aggressive investors. A huge loss could be possible along the way but because they are still young, getting back the losses and maybe doubling the returns is still very high. Those who are already near retirement age are not recommended to invest in high risk funds because of the big possibility of losing all the money that they have.
How often should I top-up my mutual funds account?
It generally depends upon the investor. Personally, the partner and I put in a little into our mutual funds account every month so that the money could ride along with the highs and lows of the market. We also follow what is called cost averaging (which will be discussed in a future post). Investing a lump sum is also okay.
How long should I stay invested in mutual funds?
This mainly depends on the type of fund that the investor has. However, mutual funds are for long term – it is recommended to stay invested for at least a year even in the funds with the lowest risk. Of course, the funds heavily depend on the behavior of the market and it is still possible to incur losses even after a year. Personally, I would recommend to stay invested for at least three to five years.
To see how much you could potentially earn by investing in mutual funds, check out this post.
If you have any other questions or clarifications, don’t hesitate to put it in the comments section below.
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Photo Credits: Lending Memo