A mutual fund is an investment vehicle that comprises a pool of funds collected from a large number of investors who invest in securities such as stocks, bonds, and short term money market instruments. The portfolio of a mutual fund is structured and maintained by fund managers.
Features of a Mutual Fund
Trading in mutual funds is carried out under strict government regulations. In accordance with the Securities Act of 1933 and the Securities Exchange Act of 1934, all mutual funds must be registered with the US Securities and Exchange Commission (SEC). Disclosure of information about relevant details and the acquired securities are also legally essential.
Specific features of mutual funds include liquidity, transfer of money, purchase of units and high competition. Investment in mutual funds is highly liquid as funds are required to redeem shares daily. It permits transfer of money from one type of fund to another, but the exchange takes place within the same fund family. Units of mutual funds can either be purchased directly or through an investment professional, such as a broker or a financial planner.
Types of Mutual Funds
Mutual funds are classified on the basis of maturity period or investment objective. On the basis of maturity period, mutual funds include open ended funds and close ended funds.
Mutual funds based on investment objectives include growth/equity-oriented funds, income/debt-oriented funds, balanced funds, gilt funds and index funds.
Benefits of a Mutual Fund
Facilitates easy access of professionally-managed portfolios to small investors. Allows investors to instantly diversify into several sectors and reduce the risk profile of their portfolio.
The cost of transaction in a mutual fund is divided among all the shareholders, which facilitates cost-effective diversification.
Enables investors to benefit from professional services like that of a fund manager.
Risks of a Mutual Fund
Separately managed accounts may perform better than mutual funds.
High risk and unpredictability of returns.
Some mutual funds over-diversify or invest within a specific sector or region. This eliminates the benefits of diversification.
Despite these risks, investors are keen to diversify their portfolios and utilize the benefits of mutual funds to earn high returns.