What is a mutual fund?

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A mutual fund is an investment instrument in which money is deposited by many investors and invested in shares, bonds and other securities. Mutual funds are used to collect scattered small capitals and convert them into investments. Funds are raised for investment through unit sales of the scheme. The collected amount is invested by the plan manager in different areas.

Investors who invest in collective investment funds become part of the fund’s portfolio. Therefore, the investor has to share in both the income and loss of the fund. Mutual funds are also considered as an easy and established means of providing diversification to the general investors. Mutual funds have existed since 1920 and have a track record of working for investors.

Although mutual funds have been around for centuries, the attraction towards them has only recently increased. According to a study by the Investment Company Institute, by 2020, 45.7% of American households will own a mutual home. In 1980, only 5.7% of American households invested in mutual funds.

How do mutual funds work?

Mutual funds are generally managed by fund managers. The decision on when to buy and when to sell securities is in the hands of the fund manager. Fund managers make investment strategies that maximize profits without losing as much as possible. To invest in a mutual fund is to invest in that fund and its assets.In other words, you invest in the entire portfolio of the fund.

Therefore, there is a difference between buying shares of a company and investing in a mutual fund. When you buy shares, you directly own a part of the company. And, you manage the ups and downs yourself. The price of a mutual fund is determined on the basis of net asset value (NAV). NAV covers all the securities of the mutual fund portfolio.

If there is investment in instruments other than securities, such as term deposits, bank deposits, etc., it is also considered as the property of the fund. Dividing the total assets thus received by the total issued unit of the fund, the net asset value per unit is found.

In Nepal, mutual funds have been selling units at the rate of Rs 10 per unit. The fund initially decides the total number of units to be issued. The fund’s investment portfolio includes a variety of securities that fluctuate in value, so the assets themselves change every day.

How to make money from mutual funds?

Investors can earn money from mutual funds in various ways. Which is discussed here:

Dividends: Like stocks, mutual funds pay dividends to investors annually. However, there is a possibility of giving both bonus and cash dividend in shares while only cash dividend is available in mutual funds. However, some mutual funds also offer the facility to reinvest dividends in the fund.
Capital Gains: If an investor sells a unit of a mutual fund for a profit, it is called capital gain. As mutual funds are also listed on the stock exchange, its shares can be bought and sold on a daily basis just like shares.
NAV: Investors can also benefit from the increase in the net asset value (NAV) of the fund. As the value of assets increases, so does the unit price of the fund. Due to which there is an opportunity to sell the unit at a profit.

Advantages and disadvantages of mutual funds:

Before incorporating a mutual fund into your portfolio, investors need to understand some of its advantages and disadvantages. The investor’s own investment strategy, goals and investment style also determine whether it is profitable or not.

Advantage

-Mutual funds provide simplicity and peace of mind as professional fund managers will manage your investments.

-Can be started with a small investment.

-As the same fund will invest in different sectors and equipments, the benefits of diversification can be taken.

-Most of the time the unit can be purchased at a fixed price.

Disadvantages:

-Professional management work is likely to be costly.

-There will be no control of investors in the decision of fund management.

-Lack of liquidity.

Types of Mutual Funds

It would be a mistake to assume that mutual funds are all the same. All mutual fund schemes have their own nature. Their purpose is also different. Here are 7 main types of mutual funds.

Equity funds: Most investments of equity funds are made in stocks and are classified according to the size of the company and market capitalization. Equity funds can be divided into growth, value or blended funds. Growth funds hold shares of companies that have the potential to perform better than the overall market.
Bond funds: These funds typically raise funds from investors to purchase short-term or long-term maturity bonds. Investors who want to diversify into bonds should consider investing in such bond funds instead of buying individual bonds individually.
Money Market Funds: These funds are fixed income mutual funds that invest in money instruments with low credit risk. Currently, such special funds are not in circulation in Nepal. Such funds typically invest in short-term treasury bills, deposit certificates, etc. Such funds are primarily aimed at maintaining liquidity and keeping the share price stable and also giving a definite return to the investors.
Balanced Fund: Currently, the number of balanced funds in Nepal is also increasing. Such mutual funds invest in both bonds and stocks. These funds determine where and how much to invest in the beginning.
Index Funds: Such mutual funds are operated keeping in view a certain market index. Index funds are designed to match the performance of a targeted index. Index funds are preferred by many investors due to their low risk, low management and low cost.
Sector or Specialty Fund: The investment of such mutual funds is accumulated in certain industry or market sector. For example, real estate, technology or the health sector. Such funds are not diversified as they are established to invest only in certain areas. But mixing such funds with other funds or investments seems to be beneficial. However, such funds have not yet come into operation in Nepal.
Target Debt Funds: Such mutual funds are operated with a target maturity date. During this period, such mutual funds have mixed various assets in their portfolio. The risk-bearing capacity of such funds also increases over time. Such a mutual fund is believed to be very effective for retirees.

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