By elmads

It is beyond doubt that not all individuals in this world will have the passion and interest with investing. This is because there are other categories, hobbies, and life beyond finance that each and one of us will fall in love with, such as health, nature, politics, animals and many more.

That being said, everyone of us also understands the need to multiply and grow our hard-earned money in order to attain our financial life goals and objectives which are related to what we are passionate about is also important. The dilemma here is that some people do not have the time to study and learn all of the information regarding investing. With that problem came a solution made by the financial industry, and that is through mutual fund investments or also known as the pooled fund investments.

What is a Mutual Fund

Some of you might have heard of mutual funds already, either from your relatives or friends. It is one of the popular, if not the most popular, investment vehicles that people utilize in today’s era. This is because investors who invest in mutual funds do not need to do their own research and study about the markets anymore, instead it will be the professional investors who will handle and invest others’ hard-earned money in their behalf.

With this trust comes with the expectation that these professional investors will do well to increase their investor’s returns in the long run. But there is a catch, as like with any other professionals, we will need to pay them professional fees for handling our investments.

Mutual funds are pool of funds (money that came from small capitalize individual investors, like ourselves), which is being handled by fund managers. These fund managers will do the research and analysis in order to make the decision in our behalf, they will invest the money depending on the fund’s investment objectives.

(Note: There are thousands of mutual funds worldwide, each and every mutual fund has their own investment objectives such as mutual funds that invest purely in bonds, mutual funds that invest only in stocks, mutual funds that invest in money market funds and many more. That is why it is important to read the terms, conditions and prospectus of the investment vehicle before we place our hard earned money with it.)

Below is an infographic flow of how mutual fund works.

So how do fund managers gain money then? They gain money through the following;

• Fund fees that the small capitalized investors pay. It is the amount of money we need to pay for as the managers of our funds, this includes the buying and selling of securities.

• The Account fee, it is different from the fund fee as the account fee covers the cost of running the services, customer support team, and keeping the investment secure.

• Some funds take a percentage of the dividends they receive from the assets that they are invested in before they distribute it back to the investors of their fund.

All of these are indicated in the mutual fund’s information sheet and prospectus. Again! read and understand the terms and conditions of the funds you are invested or are planning to invest in.

Below is another infographic picture about mutual funds

Types of Mutual Funds

The types of mutual funds are dependent on the basic asset classes, which I discussed in my blog titled “The 5 basic Asset Classes”.

Moreover, there are a lot more of mutual funds in the world, and are too complex enough to discuss but I will give two well known mutual funds that passive investors utilize. (Passive Investors are the people who religiously place money in a their chosen mutual fund, usually every month, and do not care about the fluctuations of the market price)

• Balance fund – these are mutual funds that invest on both stocks and bonds. This is to remove the hassle of individual investors to allocate and reallocate their investment portfolio. Investors seek these kind of mutual funds because it gives protection from large price drops from the securities markets when problems occur just like last March of 2020 (pandemic market crash), this is because bonds are considered as a less risky investment in terms of volatility compared to stocks.
  
  Technically speaking having bonds in our portfolio dampen the blow of our overall portfolio returns. Sample of balance fund stock & bonds allocation are, 80/20% stocks & bonds, 60/40% stocks & bonds, and 50/50% stocks & bonds.
  
  Below is an example of Vanguard’s Balance Fund which is called the LifeStrategy Fund. (NOTE: Vanguard is one of the top investment fund companies in the world that invest the money, in behalf, of their investors)

• Target date funds – these are mutual funds that invest based on the year that an investor will retire, it is same as balance fund in the sense that they both invest in stocks and bonds. The only difference is that in balance fund, it will be us investors who will decide which percentage allocation of stocks and bonds we would like. Whereas, in target date fund, the percentage allocation of stocks and bonds are distributed already depending on the number of years left before the investor’s set retirement date. Below is an example of Vanguard’s Target date funds, which they called Target Retirement fund.

It is straightforward, if we deem that we will retire in the year 2055 then we can choose that Target Retirement 2055 Fund. This depends on each and our goal for retirement, which are commonly based on our age, the place and country where we will retire, and our lifestyle.

The Advantages

• Diversification – Mutual funds are invested in different securities depending on their fund investment objectives. Most mutual funds are invested in more than 10, sometimes even more than 100 kinds of securities within their portfolio. For instance, a fund that is invested in the S&P 500 which is the top 500 companies in the US, means that the fund will also invest in all of the 500 companies that the S&P 500 holds. Having more than 20 securities gives protection from possible complete destruction of your portfolio because it averages out all of your portfolio holdings which is the best trait of diversification, whereas investing in just one stock could lead to massive decline in its stock price in the long run when not properly researched and studied. See photo below;

The sample illustration above is the Fidelity mutual fund that is invested in the top 500 companies in the US. As you can see, the equity holdings (same as stock holdings) is currently at 505 stocks. This means that this fund has invested in other 5 more extra assets. Their top holdings are always shown in their fund profile, also this fund’s inception date was in 1988. (NOTE: Fidelity is also an investment fund company that invest in behalf of its investors, which is same as Vanguard.)

• Accessibility – investing in mutual funds today is very easy, just like investing in stocks we just need to find which investment fund company we trust and want to open an account with, then we open an account online with the required documents needed, once approved we can now top up the money we are willing to invest, then choose a fund of our choice.
  
  Alternately, unlike stocks that we need to monitor and know either the stock price chart or its underlying business, with mutual funds we could only just know the basics such as what are the fund’s goals, objectives, professional fees and its inception date (this is because funds that have been operating for more than 5 years or at best more than 10 years, are established, and most of the time they have a lot of individual investors invested in it).
  
  In addition, mutual funds have medium to high liquidity (this is dependent on the country as well) as we can sell it within the day and receive the money either the same day or the next day, except for weekends and it also depends in the country.

• Professional management – This is one of the reasons for investing in mutual funds, there will be fund managers who are highly skilled and trained to do the research and investment decisions for us. It is literally someone doing the work for you. Nonetheless, decisions made by fund managers depends on the fund’s investment goals whether it is an active or passive investment fund.

Active funds – the goal of this type of fund is to beat the general market that it follows. In particular, active fund managers buy, sell and hold stocks in order to beat the returns of the S&P 500 index. (Some people say that the S&P 500 index is a reflection of the overall health of the US economy, but this is not always true.)

Passive funds – the goal of this type of fund is to mirror and mimic the general market it follows. It does not try to beat the market.

• Variety of fund choices – different mutual funds have popped up like mushrooms all over the world. Before it was just the usual popular securities market funds, but now there are various choices that investors can chose from, such as emerging market funds which are invested in countries that are not yet fully considered a developed country but can be in the near future, like the Philippines. And, there are the Environmental, Social and Governance funds (ESG) which are invested in company stocks that do not contribute into the destruction of the environment and society namely, tobacco, alcohol, natural gas, nuclear and others more.

Moreover, investors could also choose what type of investment strategy they would like such as growth, value, and dividends. Or in a specific country’s market or region. Also, other funds are invested in other asset classes that we might want.

The Disadvantages

• Fluctuating investment returns – Just like any other investments, there is no guarantee that the investment you placed in a fund will always be at the positive side, as prices fluctuates most of the time. Furthermore, there is a chance that funds can stop its operations if there will be no demand for investors. Possible problems to that can occur to a fund like the fund manger is not delivering the fund’s goals or worse, take the money they hold and run away. What is important here is to be invested in funds that have long operational track records and have a lot of investors that are invested in it, because this signify that there is demand for the fund and that it is less likely to cease its operations.

• Over-diversification – It does not mean that the fund invest in more than 100 securities, that it is properly diversified. Some funds might have invested in let’s say 500 stocks but it can be highly correlated to each other. The purpose of diversification is for risk protection of having to lessen price fluctuations. That is why some funds are diversified and invested into not just only stocks, but also on other asset classes. So, if one asset goes down the other one goes up, this will aid our portfolio to not take a big hit in its returns, in short it decreases volatility.

• Average returns – Funds rarely outperform the general market in the long run, not even active funds can sustain a long outperformance of the market. That is why investors who place more time and effort to study, research and analyse the underlying business tends to have a long-term outperformance of the markets, if done right and with discipline. This is where the 7%-9% long-term annual return has been based from, which is the US market’s return for roughly a century old. (The US stock market has the longest track record in the stock market history worldwide).

• Active fund management – Fund management have their flaws, studies have shown that active funds do outperform the general markets, only in the short-term horizon. In addition, they rarely outperform the markets consistently and not even in the long run. Also, fund managers buy and sell securities which just incur more fees every time they transact, that is why fund fees for active funds are higher than passive funds. Remember that mutual funds are not exempted from the trading expenses and taxes. And lastly, individual investors will always pay for fund management fees even if we loose money or gain money. The fact that we still need to pay for their expertise either in good or bad market conditions is just a significant disadvantage.

To Sum It Up

Every investment vehicle has its own purpose, this is why we need to review our own investment goals and objective to see if mutual funds have a place in our own portfolio.

Furthermore, investing in mutual funds are for everyone, even for the people who do not have time to learn about investing. What is essential here is the habit of investing, for the purpose of making money work for us in the long run. As like what Warren Buffett advised and quoted;

“A low-cost index fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth.

See the continuation of this blog, titled “Passive and Active Funds”

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.