How They Work Mutual Funds
A mutual fund is a collection of stocks, bonds, or bonds. When you buy a mutual fund, you own the share of the mutual fund. The price of each share in the mutual fund is called the NAV or net asset value. This is the total value of all the bonds you own divided by the number of shares in the mutual fund. Mutual fund quotes are traded continuously, but their prices are adjusted at the end of each business day.
Equity funds are concentrated in companies with shares that are listed on one of the stock exchanges. Some mutual funds invest based on the size of the company. These are small, medium, or large-cap funds.
Others invest in the type of company. Growth funds focus on innovative companies that are expanding rapidly. Value funds focus on companies that others may have overlooked. Likewise, high-tech funds can also have many growing companies. Top-tier funds also have many valuable companies.
You may want a fund that focuses on companies that issue dividends. Many of them are also top-tier or valued companies.
Many funds are concentrated in geographic areas. Domestic funds buy only US-based companies International funds can choose the best-performing countries anywhere in the world. Border markets target smaller countries like Argentina, Morocco, and Vietnam.
Emerging markets funds focus on good companies from Russia, China, and other countries in the MSCI Emerging Markets index.
You should invest in mutual funds rather than stocks if you don't want to research the financial statements of each company. Mutual funds also provide instant diversification. For this reason, mutual funds are less risky than individual stocks.
If a business fails, you will not lose your entire investment. For this reason, mutual funds provide many of the benefits of investing in stocks without some of the risks.
Bond funds invest in bonds that generate fixed income. They became popular after the 2008 financial crisis. Investors who suffered burns during the 2008 stock market crash headed for safety. They were attracted to bonds despite historically low-interest rates.
The safest are money market funds. They buy certificates of deposit, short-term treasury bills, and other money market instruments. Because they are so safe, they offer the lowest performance. You can get a slightly higher return without much more risk with long-term government debt and municipal bonds.
Higher returns and higher risks occur with corporate bond funds. The riskiest bond funds have high-yield bonds. As the Federal Reserve continues to raise interest rates, this could trigger defaults.
Some funds differentiate between short, medium, and long-term bonds. Short-term funds are safer but have a lower return. Long-term bonds are riskier because you hold them longer. But they offer greater profitability.
Many bond funds have the same bonds. If one manager starts selling that bond, others will follow suit. But there would not be many buyers for these bonds. Low liquidity would force prices to fall further. Bonds would be subject to the same volatility as stocks and commodities. This could trigger a liquidation that could destroy many funds. Examples of this scenario occurred during the title's "flash crash" in October 2014.
Actively Managed Mutual Funds vs. index funds
All mutual funds are actively or passively managed. Actively managed funds have a manager who decides what security to buy and sell. They have an objective that guides the investment decision of the manager. The manager seeks to outperform his index by selecting investments carefully selected by professional financial managers. As a result, their fees are higher due to increased expenses to finance these investment managers.
Index funds correspond to an index. Since they don't need much negotiation, their costs are lower. As a result, these funds have become more popular since the Great Recession.
Pros and cons
Mutual funds are less risky than buying individual bonds because they are a diversified investment. It doesn't depend so much on an individual stock or title and its underlying company. If one of the companies goes bankrupt, you will have many more actions to protect your investment.
Actively managed funds offer the benefits of stock selection and professional portfolio management. No need to search thousands of companies. The managers are experts in every area. It would be nearly impossible for you to become an expert in all the areas you would like to invest in.
But mutual funds still take a long time to research. To make matters worse, fund managers change. When this happens, it can affect the performance of your fund, even if the industry is doing well. This is important because managers continually change the stocks they own.
Even if you look at the prospectus, it may not reflect current ownership of the shares. You don't know what you are buying specifically, so you rely on the manager's expertise.
The prospectus cautions that past performance is not a guarantee of future performance. But past performance is all you need to keep going. There is a good chance that a fund that has outperformed the market in the past will underperform in the future. This is especially true if the manager changes.
The biggest downside is that mutual funds charge annual management fees. This ensures that they will cost more than the underlying stocks. These fees are usually hidden in various places on the prospectus.
To choose good mutual funds, you must understand your investment objectives. Saving for retirement or setting aside some extra money for a rainy day? Stock funds would be better for long-term retirement investments, while a money market fund would be better for short-term savings. Work with a certified financial planner. He or she will help you determine your best investment and asset allocation strategy.
Mutual fund companies
Mutual funds are managed by hundreds of companies, each with hundreds of funds. Most companies focus on specific strategies to stand out from the crowd. Here are the top 10 mutual fund companies by size, with their focus:
Vanguard - low administration fees.
Fidelity: complete financial services.
American: Conservative investment strategies with a long-term investment horizon.
Barclays: Target professional investors, not individuals.
Franklin Templeton: Bonds, Emerging Markets, and Value Companies.
PIMCO - Bond funds.
T. Rowe Price: free funds.
State Street - Targets professional investors, not individuals.
Oppenheimer - actively managed funds.
Dodge & Cox: no-load mutual funds.
How Mutual Funds Affect the Economy
Mutual funds are an essential component of the American financial markets. A good mutual fund reflects the performance of an industry or another sector. Mutual fund values change daily. This demonstrates the value of the assets in the fund's portfolio.
The economy is moving much slower, so large swings in a fund don't always mean that the industry is changing that much. But if the price of a mutual fund falls over time, the industry it tracks is likely growing more slowly as well.
For example, a mutual fund focused on high-tech stocks would have done well until March 2000, when the tech bubble burst. When investors realized that high-tech companies were not making a profit, they began selling stocks. As a result, mutual funds declined. As mutual funds and stock prices fell, high-tech companies were unable to stay capitalized. Many filed for bankruptcy. In this way, stock mutual funds and the US economy are interrelated.
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