Investing 101 – What is a Mutual Fund?

In our previous article, we discussed the importance of investments and some investments that one can make in preparation for their retirement. We also mentioned the mutual fund as one of the best vehicles for long-term investment for any retiree, or for anyone in general.

What is a mutual fund? And why should investors go for this? Let’s first discuss the definition and then we will move on to the benefits.

Definition

By definition, a mutual fund is a collection of investments from various people that are then managed by a portfolio specialist. The total amount pooled together from the contributors is then used to purchase holdings in various financial instruments, including stocks.

Take note that you, as a mutual fund investor, do not hold actual ownership in the financial instruments invested in. This is because those instruments are purchased in the name of the mutual fund, not yours. However, you have ownership over the earnings realized by that investment.

How Does One Earn From a Mutual Fund?

You earn from your shares in the mutual fund’s earnings. This is where the similarities with stock investing lie.

When you invest in mutual funds, you are buying shares at certain amounts per unit. Let us say that a unit costs you $1.5 each, and the minimum investment is at $1,500. This means that you’re investing a minimum of 1000 units at that time.

However, just like stocks, prices change for each unit every day.  Let’s say, at a certain point in time, the price changes to $5 each and you have 1000 units or shares owned in the mutual fund. Multiply 1000 shares by $5, and you have $5,000 worth of shares in the fund.

Do the math – you’ve gained $3,500 on your investment. Of course, this is a theoretical situation, and the real deal might be a little different. However, that is the concept of how one can earn from a mutual fund.

Benefits of a Mutual Fund

We come now to the topic of benefits and advantages. Just what makes mutual funds advantageous to an investor?

First, you attain instant diversity, which is what every investor should be thinking about. This is because your money is used to purchase more than one type of stock. The strategy used by mutual fund managers is to diversify into different stocks, with combinations of high-yield, low risk and medium risk financial instruments to maximize the movement of the mutual fund’s price.

Second, you don’t need to strategize or plan for yourself what your investments should be. The fund’s managers are well-equipped with the necessary knowledge to make the right decisions on concerns, like exit and entry points for investment, on your behalf. All you need to do is just receive the reports, read it, and nod your head in satisfaction at the fund’s performance.

Again, the mutual fund is just one type of investment that you make as you get ready to retire. There are many others, which we might just discuss in future blogs for your perusal.

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