Investing in mutual funds has become increasingly popular in recent years, especially among the young generations – millennials who are building their career or Gen-Z who are starting to become financially independent. The old belief that you should save what extra money you have has long been forgotten, replaced with the idea that investment is a more practical way to grow your money.
Mutual funds are a popular choice because of the many benefits they provide.
For one thing, individual investors can begin investing low and growing their investment as they get familiarized with the ins and outs of investment. Investors can also diversify their investment across different stocks and instruments like startups, legacy institutions, and even precious metals like gold and silver. And mutual fund investment does not require one to open a Demat account.
A Dematerialized account is a type of account that holds financial securities electronically and in India, these accounts are maintained by the National Securities Depository Limited and Central Depository Services Limited. For first time investors, they hate the idea of opening a Demat account because it costs money to operate and younger investors, in general, prefer to be flexible with how they invest their money.
Mutual Fund Basics
Investors in mutual funds don’t have to do the heavy lifting of picking individual stocks they want to invest their money in. Mutual funds allow regular people who wish to invest to pick and choose the types of funds.
It works by pooling an individual’s money with those of other investors and investing it into a portfolio of assets like bonds, stocks, etc. Normally, such a portfolio would be too out of reach of your average investors to partake in but since you are investing along with other investors, you gain such access.
There different types of mutual funds like large-cap, mid-cap, and small-cap. There are also mutual funds that are focused on telecommunication, biotechnology, and energy across different regions of the world.
Why is it popular?
Mutual funds have become the rigueur in investment because it allows average investors to pick one fund that contains different stocks and not have to worry about putting all their eggs into one basket, so to speak. They also don’t have to put in the time to monitor real-time updates of their investment as you would with individual stocks.
Mutual funds offer immediate diversification as each fund holds different stocks.
Mutual funds are normally managed by a manager who picks the investments within the portfolio. This is one of the main selling points for beginners who are not too familiar with investing and would prefer an expert to take care of the rest.
How does it pay?
Investors get paid in two different ways in mutual funds: distributions and capital gains.
If a fund has an asset that pays dividends, the manager distributes the dividends to the fund owners. The distribution can also be in the form of capital gains and interests.
You accumulate capital gains money when you decide to put your mutual fund up for sale for more than what you paid for it initially.
One of the most important factors in determining the dollar amount you receive depends on your fund manager. It benefits them if they choose which assets to invest in because they also get a slice of the payout. So does that mean fund managers regularly beat the market?
According to Dow Jones, large-cap mutual fund managers failed to beat the market in 2016, by as much as 66%. The numbers are even dire for mid-cap and small-cap managers. The same study explored the performance of actively managed mutual funds along a 15 year period and more than 90% failed to beat the market.
Advantages and Disadvantages
- For those who want a hands-off approach in investing, then mutual funds are a great place to start. Investors don’t have to worry about managing their funds daily or keeping up-to-date with industry trends.
- The funds also hold a lot of stock. In the event that one company tanks, investors don’t lose everything as there are other companies that their investments are spread over.
- Mutual funds are a good entry point for people who want to go into investing. They can easily diversify their investment while learning the ropes.
- Most of the funds charge expense ratio as well as upfront fees for being managed by an expert.
- If you invest in two funds with overlapping investments, your portfolio is less diverse. Case in point, if you have two funds that hold Hyundai and the company bombs, your loss is doubled.
- Mutual funds rely on experts to manage your money and they rarely beat the market.
Types of Mutual Funds
The types of mutual funds to choose from are astounding, with each one carrying their own benefits and drawbacks. Investors can pick a mutual fund to invest in based on different factors such as risk, return, geographic area, sector, and many more.
Let’s take a look at the four most common types of funds people pick.
Also known as fixed-income funds, this type of fund trade and invest bonds. Bond funds typically have higher returns but come with more risks since it is sensitive to interest rate risks.
Money market funds:
These are short-term, high-quality investments in securities that are issued by the government or corporations. They offer the lowest returns but these funds are also low risk.
Also known as stock funds because they invest in company stocks, equity funds belong in one of three categories: large-cap, mid-cap, and small-cap. Large-cap include blue-chip organizations like Google and Apple. Mid-cap are companies in the mid-range. Small-cap are small companies, usually start-ups.
Such funds carry a mix of bonds, stocks, and other investments. Hybrid funds can even invest in other mutual funds.
Investment is a great way to grow your money instead of hiding it away in a bank that only offers very little interest. Mutual funds are a great way to jump-start a career in investing and could potentially pay out big time but only if you are careful with the type of funds you invest in and working with a fund manager you trust.