The world of finance is frothing at the brim with different financial tools to satisfy the palette of every would-be investor, making finding genuinely good investments a time consuming job. However, some of the oldest and simplest vehicles, mutual funds, offer one of the best havens for your hard earned cash. So, let’s take a closer look at mutual funds and try to figure out how you can find the best investments for your money.
To better explain a mutual fund, I will resort to a simple analogy:
Let’s say you want to buy a piece of land, but you don’t have the necessary capital. As a result, you go to your relatives and closest friends and convince them to invest money with you on condition that each one of them would own a part of the land.
However, none of your relatives and friends will have a say in how you invest the money; you have complete autonomy. Now, with the pool of collected funds, you can buy that piece of land and wait for it to appreciate in value.
Afterwards, some of your more distant friends, having heard of your recent successes in the real estate market, decide to give you some of their money to invest along with the pool you already manage.
So, you go out looking for other pieces of land and find a large building which you can rent out. Once you’ve bought the building, you collect the monthly rent, only to distribute that income proportionally over the participants in your pool.
Every time a new individual comes to invest in your pool, you perform a quick calculation to figure out how much this individual is contributing: you calculate the net asset value (NAV), which is basically the value of all the properties you own, and compare that to the amount the new investor is bringing.
In fact, to make things easier, you’ve decided to just issue shares, and any one is free to buy these shares. The value of each share is equal to the net asset value divided by the number of shares you issued, which will be called the net asset value per share (NAVPS).
Finally, seeing as how managing this pool of money is extremely time-consuming, you have decided to give yourself an annual salary, which will be equal to about 1% of all the money managed.
Congratulations, you have just created a real estate mutual fund.
Buying assets with the use of pooled capital is what mutual funds do. Nevertheless, just as in our example, none of the individual investors can affect the direction the fund takes; only the fund manager gets to steer the ship.
As a result, mutual funds are quite costly, be it the management fees, the exchange fees, distribution and service fees or other expenses. In return, a mutual fund can make money in one of two ways: either the assets increase in value creating capital gains or the fund collects a form of steady income, such as dividends and interest, from its investments.
The value of a fund is contingent upon the aggregate sum of all of its assets, which is the same as saying that the value of the fund in our example is equal to the sum of the value of all of the properties it owns.
Our example illustrated only one kind of fund: a specialty fund focusing on real estate. In actuality, there are numerous types of mutual funds, among which are funds that:
- focus on short-term government bonds (aka money market funds),
- funds that focus on more lucrative but risky bonds like corporate bonds (aka fixed income funds)
- funds that focus on stocks and company shares (aka equity funds)
- funds that split their portfolio between stocks and bonds (aka balanced funds)
- funds that grow and shrink with the general market (aka index funds)
- funds that focus on a specific sector of industry or geographical region (aka specialty funds)
- funds that invest in other funds (aka funds of funds)
- and funds that focus on international and foreign markets (aka international/ global funds).
Each kind of fund has its own advantages and drawbacks and can be separated into further different subtypes of funds.
Besides focusing on different assets, each fund differs from the other with regards to its objectives and investment strategy. An aggressive mutual fund will pursue high rewards while bearing the higher risk, while a conservative mutual fund will do the exact opposite.
Having taken a quick foray into the world of mutual funds, let’s see what goes into picking the perfect mutual fund for you:
1. The first thing you need to do is to set clear goals and objectives for your investments. This can be achieved through answering pivotal questions like whether you are after long-term capital gain or a more immediate source of income. You have to figure out how long you are willing to let your money be tied up in assets as well as how much risk you are willing to shoulder.
Furthermore, it is important for you to identify the different kinds of investments you’d prefer: are you looking for devoting all your money to the real estate sector or do you want to invest some of your money in foreign stock markets? Do you want to invest your money in socially responsible corporations or are you indifferent to that aspect?
2. There are a few other issues you need to face, including the amount of money you are willing to invest, your concern for taxes, and your keenness to beat the market.
3. Once all these questions are answered, your next move is to start looking for funds that meet your criteria. Some things to look out for when selecting a fund is its past performance, its proneness to risk, its associated fees, its size (which is the amount of assets and capital within it), its price, and its managerial team.
Each one of these factors plays an important role in sketching a more complete picture of the fund and its prospects. In addition, compare the fund’s previous results with those of the general market: A fund that proves much more volatile than a standard index can mean trouble.
4. There are countless websites and resources that can help you in your search for that ideal mutual fund. Online service providers such as MAXFunds, Fundreveal, Morningstar and Kiplinger all offer information about the numerous mutual funds out there. Some service providers go an extra step by evaluating the funds for you, based on a set of criteria.
Hopefully, by now you can see that finding a solid mutual fund to invest in is easy; it just requires you to know what you want and to do your homework.
After all, the best investments are the ones that are tailored for the investor. And remember, should you at any point in time feel overwhelmed by any of this, feel free to consult a financial advisor; they would only be too happy to help.
This article has been contributed by our friends at SlickBucks.