A mutual fund is one of the most well-known types of investment fund. They follow the standard rules of investment funds, in that there are a group of investors all with an individual financial stake. Understanding whether mutual funds are right for you is essential because having all the facts before you start enables better investment decisions.
What is a mutual fund?
A mutual fund is a type of investment fund. As an investor with a financial stake, you buy a share of the fund alongside a number of other parties. This share is representative of the assets in the fund, and these can increase or decrease on any given trading day.
How do mutual funds work?
The most important thing to know about mutual funds is that you do not own the shares they represent. Your money buys a share in the mutual fund itself and the total value is known as the NAV, or Net Asset Value. The NAV is calculated in a very specific way. Firstly, the total of the fund assets is observed, and this is then put into context with the shares that remain outstanding by dividing to ascertain the correct figure.
How do you make money?
All of this translates into three ways to secure a return on your initial investment.
- Individual Sales: When a share price increases, but it is not sold, you are able to still sell this share if you wish.
- Dividends: Dividends are a proportion of profits from the company/security within the mutual fund. If a company decided to put dividends on the table, you will have a choice as to whether to accept the offer or not.
Fund Sales: If securities see a price rise, these can be classified as capital gains. As an investor, you may see a profit from this alongside all the other investors with a claim in the mutual fund.
What are the benefits of investing in mutual funds?
When it comes to the benefits of mutual funds, there are three clear ones to speak of. Firstly, given that they are an active investment, the majority (unless stated otherwise) will be controlled by a fund manager who executes important trade decisions and handles all the major movements. Secondly, this type of investing is considered a low risk comparatively because the portfolio is diverse, and the risk is therefore spread out. Don’t forget, a mutual fund can contain up to 200 fund assets at any given time. The last advantage is that they are well suited to the newest of investor and the veteran too. They are straightforward, and the concept is accessible in the wider investment picture.
What is the difference between a mutual fund and an EFT?
Mutual funds and exchange-traded funds (ETFs) are both types of investment funds that pool money from multiple investors to invest in a diversified portfolio of securities. However, there are some key differences between the two.
While both mutual funds and ETFs offer diversification by investing in a variety of assets, ETFs are typically more cost-effective, more tax-efficient, and offer more flexibility in trading than mutual funds. However, mutual funds may be a better choice for investors who prefer a hands-off approach to investing and do not want to actively trade their investments during the day.
What are the tax implications of investing in a mutual fund?
Capital Gains Tax (CGT) will be due on any capital gains above your personal allowance, which is currently £6,000. However, funds that are in tax wrappers such as ISAs and pensions do not get charged CGT.
What are the fees associated with a mutual fund and how do they affect returns?
There are associated fees to consider. These are typically:
- Loads: Commission-style fees that are triggered when a sale is made.
- Redemption: If you decide to sell after a short period, you may be charged the redemption fee.
- Administration Charges: Standard charges issued for the services of a fund manager.
- Mutual funds are a type of investment fund with a fund manager. They are well suited to both beginners and expert investors because they are considered a low-risk strategy that usually sees a decent return if handled wisely.