Mutual Fund Investing for Beginners

 A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or a combination of these investments. The combined holdings that the mutual fund owns are known as its portfolio. The investment portfolios of mutual funds typically are managed by separate entities known as ‘investment advisors’ that are registered with the SEC.

 NAV: Net Asset Value is the sum total of the market value of all the shares held in the portfolio including cash, less the liabilities, divided by the total number of units outstanding. An NAV is undertaken once at the end of each trading day based on the closing market prices of the portfolio’s securities.

 For example, if a fund has assets of $100 million and liabilities of $20 million, it would have a NAV of $80 million. If the fund had 8 million shares outstanding, the price-per-share value would be $80 million divided by 8 million, which equals $10.

 The advantages of investing in mutual funds are:

•  Professional management: Professional money managers research, select and monitor the performance of the securities that the fund purchases.
•  Diversification: Diversification allows the distribution of investments across wide range of companies and industry sectors. This helps in lowering the risk, if a company or sector fails. 
•  Affordability: Certain mutual funds accommodate investors with less money to invest, by setting relatively low amounts for initial purchases, subsequent monthly purchases, or both
•  Liquidity: Mutual fund investors can readily redeem their shares at the current Net Asset Value (NAV). Including any fees and changes assessed on redemption at any time.

 On the basis of their structure, mutual funds are classified into the following major types:

•  Open-ended funds: open ended fund is a type of mutual fund where no restrictions are put on the amount of shares, the fund issues. If there is a high demand, the fund will continue to issue shares despite the number of investors. Open ended funds also buy back shares when investors wish to sell. Open ended mutual funds are generally managed actively and are priced according to their net asset value. Open ended mutual funds are more common than closed ended funds.
•  Closed-ended funds: Closed ended mutual funds are financial securities that are traded on stock market. Similar to a company, a closed ended fund issues a fixed number of shares in an initial public offering, which trade on an exchange. Share prices are determined by the investors demand and not by the total net asset value. A sponsor, either a mutual fund company or investment dealer, rises fund through a process known as underwriting to create a fund with specific investment objectives.

 On the basis of investment options, mutual funds are classified into the following types:

•  Money Market Funds: Money market funds have relatively low risks, compared to other mutual funds and most other investments. By law, investment can be made in only certain high quality, short-term investments issued by the government, corporations, state and local bodies. Money market funds pay dividends that generally reflect short-term interest rates, and historically the returns for money market funds have been found to be lower than for wither bond or stock funds.
• Bond Funds: Bond funds generally have higher risks than money market funds. This is mainly because bond funds typically pursue strategies aimed at producing higher yields.
• Stock Funds: Although stock fund’s value can rise and fall quickly over the short term, historically stocks have been found to perform better over the long term than other types of investments – including corporate bonds, government bonds and treasury securities.

 The following are different types of stock funds:

 Growth funds: Focuses on stocks that may not pay a regular dividend but have the potential for larger capital gains.

• Income funds: Invests in stocks that pay regular dividends.
• Index funds: Aims to achieve same return as a particular market index.
• Sector funds: Specializes in a particular industry segment, such as technology, infrastructure or consumer products stocks.

 How you can invest in mutual funds: There are two ways in which you can invest in a mutual fund.

 One time outright payment: Let’s say you want to invest $1000. All you have to do is approach the fund and buy units worth $1000. There will be two factors determining how many units you get. Entry load, this is the fee you pay on the amount you invest. Let’s say the entry load is 2%. Two percent on $1000 would $20. Now, you have just $980 to invest. NAV, The Net Asset Value is the price of a unit of a fund. Let’s say that the NAV on the day you invest is $10. So you will get 98 units ($980 / $10).

•  Periodic investment or SIP: That means that, every month, you commit to investing, say, $1000 in your fund. At the end of a year, you would have invested $12,000 in your fund. Let’s say the NAV on the day you invest in the first month is $10 and you will get 100 units. The next month, the NAV is $20 and you will get 50 units. The following month, the NAV is $18 and you will get 55.55 units. So, after three months, you would have 205.55 units. On an average, you would have paid around $14.59 per unit. This is because, when the NAV is high, you get fewer units per $1000. When the NAV falls, you get more units per $1000.

 Advantages of investing through SIP:

 With SIP you can invest small amounts periodically, in this way investments do not appear to be a burden every month.

• The biggest advantage is cost averaging, which means over a period of time, with the ups and down movement of stocks, the risk reduces and your gains increases. Investing in an SIP of an equity fund is one of the best ways to beat inflation.

 How to calculate your return on Mutual fund:

 (Current value of units – initial investment) / (initial investment) X 100

 Let’s say your account is worth $1200 now and have initially invested $1000 then the return is 20%

 = ($1200-$1000)/($1000)X100

= ($200)/ ($1000) X100

=0.20X100

=20%

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