The total net assets of mutual funds worldwide were over $14 trillion in March of this year.
Mutual funds are a hugely popular investment vehicle globally. However, there are a huge number of them out there, with the quality of returns varying significantly from one to the next.
For a newcomer to the world of investment, it can be difficult to know what to look for in a mutual fund. The best performing mutual funds in the past may not continue to post exceptional returns in the future, especially in these uncertain economic times.
Read on as we take a closer look at mutual funds, and what to look for when investing in one.
What Is a Mutual Fund?
A mutual fund is a type of investment fund. A team of professional investment managers take capital from a large number of investors and invest the resulting pool of money in various securities.
Essentially, it is a means of investing in capital markets indirectly. Rather than picking stocks or bonds and putting money into them yourself, you allow a mutual fund manager to make the choices for you.
The advantage of this is that your investments are made by a highly experienced investment professional. This is safer than picking investments yourself, especially if you’re new to the world of investment.
The Different Types of Mutual Fund
There are many different mutual fund types. You can categorize them on the basis of the types of securities they invest in, the way they are managed, and the level of risk they take on in seeking returns.
To pick the best mutual fund for your needs, you need to know what your investment objectives are. These will dictate the type of fund you should pick.
Index Funds
Index funds are so named because they track the performance of a given index. Common indexes that form the basis for these funds include the S&P 500, the Dow Jones Industrial Average (DJIA), and the Nasdaq Composite (IXIC).
Index funds are an example of a passively managed fund. No input is required from investment managers, as the fund simply tracks an index.
Passively managed funds typically have much lower fees than actively managed funds for this reason. As outlined below, many investors who want a passively managed fund opt for an ETF rather than a mutual fund.
Stock Funds
Stock funds invest in a range of different stocks. Unlike index funds, fund managers actively pick these stocks individually and will chop and change them based on market trends.
Stock funds are therefore an example of an actively managed fund. Their fees are higher than some alternatives.
Stocks are riskier securities than bonds or other fixed-income securities. The risk of loss with a stock fund is therefore relatively high, but the opportunity for gain is greater as well.
Investment approaches vary widely from one stock fund to the next. Some managers will make more of an effort than others to diversify their holdings and hedge risks.
Specialty Funds
Specialty funds can be thought of as occupying a kind of middle ground between stock funds and index funds. Investment managers pick the stocks themselves, but within certain boundaries.
These boundaries typically relate to a market type. For instance, a cannabis market specialty fund will only invest in cannabis stocks.
Fixed Income Funds
Fixed income funds invest in low-risk securities. These include Treasury notes and bonds, as well as highly-rated corporate bonds.
These mutual funds cater to investors who prioritize income over growth.
If you’re simply trying to manage your money better with a view to long-term savings, a fixed-income fund might be just the thing for you.
Mutual Funds vs Other Fund Types
There are other types of investment fund that you may have heard about. While these can bear similarities to mutual funds, there are important distinctions to be drawn in each case.
Exchange-Traded Funds (ETFs)
The ETF is a close cousin of the mutual fund. Both types of fund take payments from investors and use these to invest in a variety of different securities.
ETFs tend to focus more on passive strategies than active ones. Many ETFs track indexes.
Mutual funds also tend to have more complex structures and a greater variety of share classes.
Hedge Funds
Hedge funds are another type of pooled investment fund. However, there are a number of important differences to be aware of with hedge funds.
Hedge funds use a number of complicated strategies to extract higher returns from their investments. These include high-frequency trading and short selling.
Hedge funds typically charge much higher fees than mutual funds.
Because of their complex, risky strategies, hedge funds are generally only available to professional investors, or those with a large number of investable assets.
What Sets the Best Performing Mutual Funds Apart?
There are certain mutual funds that regularly outperform their competition. While it is impossible to say exactly what the winning formula is for these, there are certain things that profitable funds have in common.
The first thing you should look for is a low expense ratio. A better approach to cost management means lower costs for you, and also indicates fiscal prudence on the part of the fund managers.
For actively managed funds, quality management is the key consideration. Look for managers with a proven track record of providing results.
Putting Your Money to Work
Mutual funds are a diverse family of investment vehicles. Some are designed to seek huge gains, while others simply aim to provide steady growth for clients looking to retirement.
The best performing mutual funds have consistent objectives that they stick to. The best investors do exactly the same thing.
When you’re deciding on your next mutual fund investment, start with a clear goal in mind.
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