A Mutual fund is an investment product whereby different individuals invest their money together and collectively.
The funds which are accumulated in the pool is than used to purchase securities which include stocks of a listed company, government securities, corporate securities and money market instruments such as commercial paper, certificates of deposit and bills of exchange.
UNDERSTANDING INVESTMENT FUNDS
Now, let’s turn to the issue of how to select the best investment fund and first, consider what an investment fund is.
In other words, an investment fund is when a large number of people contribute their money to acquire different securities like shares, debentures or property.
Due to the fact of buying a number of stocks with your money you reduce your risk as compared to putting all your money in one investment. Investment funds are classified mainly in mutual funds, exchange traded funds (ETFs) and index funds, each with their distinct characteristics.
Managed investment models are by skilled persons who are given the sole responsibility of deciding where the pooled funds will go.
This makes them a viable for anyone who might not be willing or have time or knowledge on how to go about managing individual investments.
Just like While choosing college for higher studies, the first thing we need to know is what is available to us out there in order to make a proper selection from the list of options.
In layman terms, managing your investment risk levels by not investing on only one type of business or industry.
However, you need to have the following factors in mind when choosing mutual funds. To begin with, identify your financial objective- whether it’s short-term financial goal, a goal that you would want to achieve in less than a year.
ASSESSING YOUR RISK TOLERANCE
Then risk tolerance differs from one person to the other depending on their financial status, investment plan.
The types of mutual funds based on Risk level are Low Risk Mutual Fund, Moderate Risk Mutual Fund and High-Risk Mutual Fund.
There are five risk classes of mutual funds which despite having differences can fall in the very high, high, moderately high, moderate, or moderately low or low risk.
Such kind of funds provide investors’ capital to only average risk hence the name moderate risk funds. Some of the better placed moderate risk funds only invest in securities in the moderate risk category in order to retain reasonable market risk relative to inflation-adjusted returns.
Those who seek to earn high revenues in the low-risk investments have sit their money in the best moderate risk mutual funds. These schemes are therefore inclined to those investors whose main aim is to get stable incomes for their investments besides being used as a portfolio.
These funds come with certain risks based on their diversification, something that risk adverse investors need to know. For instance, the equity-based fund is on the riskier side than the fixed fund.
On the other hand, where a scheme is largely based on borrowing, medium levels of credit, inflation, and interest risks can actually become apparent.
TYPES OF INVESTMENT FUNDS
Basically, the mutual funds that investors should choose are dependent only on their investing goals and tolerance towards risk.
This is the proper selection of mutual funds that enable you to achieve life objectives in a given period.
Exemption type depends on the defined objective of the mutual fund and the asset of the mutual fund. Following are the categories of mutual funds:
- Equity Funds: These majorly involve purchase of stocks and are suitable for long term investment. Large capitalization funds are those that invest in companies having a market capitalization, exceeding $1 billion; mid capitalization funds are those investing in companies having a capitalization between $300 million and $1 billion; and small capitalization funds are those investing in companies with a capitalization of $300 million or less.
- Debt Funds: These invest in fixed income like bonds though they provide satisfactory but comparatively lower profit. They are more suitable for usage when working on a short-term financial plan.
- Hybrid Funds: These funds perform a blend of equity and debt instruments to give reasonable risks and returns to the investors.
- Index Funds: These map to a particular market index, such as the Nifty 50, and allow investors to have a cut-rate access to the equities market with very little monitoring.
DIVERSIFICATION: A KEY SUCCESS
Perhaps the most fundamental rule of investing it that one should never put all their money into one sector.
This simply refers to diversification where you diversify your investments in an attempt at reducing your overall risk.
An important criterion, which should be taken into account when choosing an investment fund, reflects how the fund contributes to the diversification of investment portfolio.
A well-diversified fund also minimizes on a situation where one investment is entirely lost due to poor performance in particular investment infrastructure.
For instance, you may opt to invest in a balanced fund instead of focusing your invest in a stock fund because the balanced fund invests in both stocks and bonds.
Like this, if the stocks are performing poorly the bonds within the fund can act as a bolster. Unfortunately, most investment funds, namely mutual and ETFs do come with quite a good level of diversification.
Costs and Fees
All investment funds have their costs and fee charges, and it is imperative to get a hold of before deciding on them.
These fees impact your profitability gradually, so it is logical to invest only in funds with low fees.
Common fees include:
- Management Fees: These are charged on the fund managers for managing the fund. There are key differences in costs; while actively managed funds often include higher management fees than passive funds such as mutual ones.
- Expense Ratios: This is the part of the fund assets used to meet administrative expenses. With lower expense ratios, a larger proportion of your money is being invested than is being paid to the fund’s fees.
- Transaction Fees: Several funds levy fees when you purchase or sell its shares. Usually, transaction costs in ETFs are lower than in mutual funds.
It is necessary to take time and read all the statements so that one may understand the charges made in relation to the various funds to invest in. In the long run the costs that may seem insignificant may cut down the value of your overall investment.
Performance History
The fact is that past performance, may not always reflect the future result, but it can give the idea about the performance of the fund in various conditions.
While assessing an investment fund for an investment, the industry standard recommends that you consider an investment fund’s experience over the last 5 to 10 years. Too, whether the fund has delivered returns that are steady? What has happened to it during market downturns?
This information needs to be compared with the benchmark index of the fund. For instance, if you are evaluating an S&P 500 index fund, please view how this fund mirrored the actual S&P 500 index.
High level of consistency in the form of high growth rate of the fund over time also gives one confidence in the management of the fund and the overall strategy on investment.
Taxes
The other factor to consider when going for an investment fund is tax. As in all investment categories, every fund has its own tax characteristics and knowing them can save you a lot of money in taxes.
For instance, index funds and ETFs themselves tend to be far better for your taxes than mutual funds due to their lower turnover rates and therefore, capital gains.
If you’re investing in a taxable account, it also makes sense to use the tax efficiency of a fund as a filter. On the other hand, if you are making your investment in tax shielded provisions for example in IRA or 401(k), the aspect of taxes need not to be of much concern because your investment grows in a tax-sheltered manner.
SELECTING A RIGHT INVESTMENT FUND
Selecting an appropriate investment fund involves evaluation of needed objectives, acceptable loss, and time period in investing.
First, eliminate based on these factors to make you to have more manageable choices. Then, estimate the efficiency, the costs, and the diversification given by each fund.
This should also take into consideration the tax effect and should form part of a comprehensive financial planning.
Spending your time on finding the differences between funds allows you to choose the one that is most suitable.
Bear in mind that nothing is safe in investments completely and that we risk something every time we invest in a project.
This is why it is crucial to re-visit your portfolio from time to time since market prices change and may so do your circumstances.
Be ready to alter your investment plan to fit the goals in order to avoid drifting off.
REGULAR PORTFOLIO MONITORING
The key message is that investing is not an event but a process, and here the author shares some guidelines.
Portfolio rebalancing as a form of analyzing your investments also helps to check if they are still consistent with the financial goals given the life’s circumstances or market conditions.
For example, if the primary goals are wealth creation as opposed to income generation, then changes in the funds may be required.
CONCLUSION
Selecting the correct investment funds can certainly become one of the key steps in creating a good base for your finances.
As people become clear about what they want to achieve, how much risk they can or are willing to take and are informed about various funds they will be in a better position to make appropriate decisions that can get them where they want to be financially.