Mutual funds are considered one of the most commonly available types of funds in the investment market. A mutual fund is a type of financial vehicle that is created by collecting money from many investors. These funds were invested in mutual funds by the investors to invest in securities such as bonds, stocks, money market instruments, and other assets.
In simple terms, mutual funds collect money from an individual or small-scale investors and use that money to buy other securities that have a possibility of generating profits or gains for the investors. The most common purchases are stocks and bonds. The value of the mutual fund is decided based on the performance of the securities it decides to buy. This decision is made by the asset managers who are responsible for investing the funds in the most profitable investments.
Mutual funds provide access for an individual or small-scale investors to access portfolios that are managed professionally. The portfolios can be identified as bonds, equities, and other securities. When investing in such portfolios, each shareholder proportionally participates in the gains or the losses of the funds.
Professional money managers are assigned to operate mutual funds. They allocate the assets in the fund in a way that they can attempt to generate income or capital gains for the investors of the fund. The portfolio of a mutual fund is generally designed and maintained to align with the investment objectives that are specified in the prospectus of the fund.
Mutual funds generally invest in a large number of securities. The performance of the fund is usually measured as the change in the total market cap of the fund derived by the aggregating performance of the underlying investments.
There is a significant difference between investing in a share of a mutual fund from investing in a share of stock. Stocks generally provide voting rights to the shareholders. But, mutual fund shares do not provide voting rights to the shareholders. A share of a mutual fund is merely a representation of investments in any stocks or other securities instead of just one asset or a holding.
Due to this reason, the share price of a mutual fund share is referred to as net asset value (NAV) per share and is also referred to as NAVPS. The net asset value (NAV) of a fund is obtained by dividing the total value of the securities in the portfolio by the total amount of outstanding shares.
Note: Outstanding shares are referred to as the shares held by all investors of the fund (shareholders, company officers, instituted investors, and insiders).
Usually, an average mutual fund holds over a hundred different types of securities. Due to this reason, mutual fund shareholders gain access to a highly diversified investment market at a low price. It helps to reduce the risk in the investment market rather than investing in one type of asset or a holding.
The typical methods of return gained by the investors of the mutual funds can be identified in three ways.
01. Investors can gain an income from the stock dividends and interest received from investing in bonds that are held in the fund’s portfolio. A fund usually pays all of the income received over the year to its investors in the form of a distribution. Funds usually allow the investors to choose either to invest the earning back in the fund to obtain more shares or to receive the income as a cheque.
02. If the fund managers decide to sell the shares for a higher price with a profit, the fund receives a capital gain. Usually, most funds pass these capital gains to the investors of the fund in a distribution.
03. If the holdings in a fund have increased in price but the fund managers decide to keep the shares instead of selling, the investors can sell the mutual fund shares in the market and gain a profit.