Last updated on March 17th, 2024 at 11:48 am
The investing world is a very broad and versatile one where investors employ different techniques and methods to maximize their investments as much as possible.
However, while risks are always part of the game, investors are usually interested in minimizing risks to the barest level.
This is one pathway that birthed mutual funds – the necessity to have the liberty to engage various investment options and get maximum returns with minimal risks.
Table of Contents
Meaning of Mutual Fund
Therefore, we can simply explain a mutual fund as a collective investment scheme that pools resources together from several interested investors, whereby the resources are then invested in different investment vehicles like bonds, stocks, as well as other available securities or assets.
The fund or scheme is a sort of bailout for investors who won’t have been able to invest in these assets or securities individually due to reasons like lack of required capital and expertise to professionally manage them.
Those that manage mutual fund are known as fund managers. These are professionals that put the pooled money into work, so it could make more money that will become profits for every investor in the system, irrespective of how much they invested in the fund.
This scheme, which is also known as Unit trusts, is usually well managed and well-coordinated by the handlers.
Each investor has their own number of shares, which equates the ownership of the fund’s holdings. The number of shares you own as an investor would also determine the return that would go to you from the fund’s profits.
Additionally, in the circle of mutual fund, the term portfolio is referred to as the combined holdings the mutual fund has. They are very organized and handled to be consistent with the investment objectives and aims.
Categories of Mutual Fund
- Open-Ended Funds, or
- Close Ended Funds.
Open-Ended Fund:
By an open-ended fund, we are talking about that which is with no restrictions whatsoever on the number of shares it will issue.
And should it happen during the course of its operations that demand gets high, the fund will still proceed to issue units. This will go on notwithstanding the number of investors there.
Another peculiarity of this type of mutual fund is the possibility of buying back units if an investor desire to sell.
Investors are thus provided with an easy investing vehicle since they can keep selling and buying back fund units at will.
Close-Ended Fund:
The opposite of the open-ended fund is the close ended-fund. The system of its operation is that a publicly traded investment company makes attempts to raise a fixed amount of capital via what is known as an Initial Public Offering (IPO)
When this is done, the fund gets structured and will be listed, with trading taking place as when stocks perform on a stock exchange.
So, basically, unlike the first one which is continuous, this one only settles for a particular amount of capital only once. This is achieved through an IPO that investors buy, whereby they get a fixed number of shares too.
While regular stocks may come to your mind when reading about close-ended stock, kindly note that they are not the same.
These ones have to do with having an interest in a specialized portfolio of securities that is professionally handled by an investment advisor. Also, they usually have their own aims and systems of operations.
Advantages of Mutual Fund Investment
Having talked about the different expressions of mutual fund, let’s now talk about some of its prominent advantages.
Dividend/Interest Payments:
Mutual funds have been structured in such a way that income is obtained as dividend payments on stocks as well as interest payments on bonds in the portfolio.
Then, the handlers would proceed to distribute a big chunk of this income to the unit holders as dividends paid out.
So, it doesn’t matter how many shares a particular investor has in the fund, they will definitely receive their own dividends too.
Capital Gains Distributions:
As stated already, the fund is usually managed by professionals who are on the lookout to increasing gains. Now, it is possible that the price of the securities owned should increase for some reason.
Then, when a security that has increased in price is sold, it means the fund will have a capital gain.
And rather than the handlers keeping the gains for themselves at the end of the year, many of them still distribute these capital gains to their several investors.
Increased Net Asset Value (NAV):
One of the technicalities attached to mutual fund is that should the market value of one’s portfolio witness an increase, as far as expenses and liabilities have been well taken care of, the value of that fund, as well as its units, would also increase.
This is another benefit investors derive from mutual funds. Indeed, the higher NAV shows the higher value of the investor’s investment.
It should be explained here that as far as dividend payments with capital gains distributions are concerned, the handlers can send their investors a form of payment, and also give them an option to either get their dividends immediately or simply have it reinvested in the scheme to buy more units.
Professional Investment Management:
One of the most obvious benefits as far as mutual fund is concerned is that you don’t have to give yourself headaches as an investor who wants their money to work for them.
Some investors go through different things just to get good stocks for themselves (and some end up making bad decisions in the process).
However, the fund managers are professionals in the investment world, and they can go for these things with great ease.
They can help manage your investment while you simply sit back to expect your gains. They have the knowledge and tools to research and choose appropriate securities.
Diversification:
It is very popular advice that we should not put all of our eggs in one basket. It is believed that all companies cannot be troubled at the same time.
All of them cannot fail at the same time. And the risk is lower when one failed.
Minimal Transaction Costs:
A fund can afford to acquire lower transaction costs because they usually transact huge amounts of securities per time (either they are buying or selling).
On the other hand, if an investor decides to transact themselves (to buy or sell securities), they have to pay more in transaction costs.
Affordability:
It is a common thing to see funds that allow investors with small capital to be part of the system.
For instance, 2021 MTN public offer allowed investors to buy with as low as NGN3, 380 which was held between December 1 to December 14, 2021.
Many of them accommodate low-income earner investors by setting affordable low amounts for purchases.
If you want to buy certain government bonds all by yourself for instance, you may need to have a whole lot of money.
However, a mutual fund can pool resources together from different investors, and they can conveniently afford it.
Liquidity:
One other advantage of this is that you are permitted to convert your shares to cash at any time you desire. Not every investment vehicle would allow such. But here, you can simply redeem your shares at the current NAV including the fees engaged on redemption at any moment.
Simplicity:
There is no huge complexity attached to buying a mutual fund. This is something easy, and can be done once you are ready.
Investor Information:
You can constantly get up-to-date reports from the handlers of the funds, and contact them for whatever it is you want to know.
Many of them now have a website to make this easier. You can simply surf their website so you know their daily pricing and performance results. You can also decide to send the fund managers an email too.
Life Cycle Planning:
It is possible to get one’s investment plans linked to future persons as wished, so they can take advantage of the return. It is possible to keep making up-to-date changes as one’s life cycles are changing.
Hence, investors can be futuristic and can, for instance, place resources in growth funds for future academic tuition needs. All you need is to discuss with the managers, and they can always accommodate your permissible requests.
Regulation:
Investors must be always careful not to jump at investment vehicles that are not regulated, so they won’t end up losing their money.
However, it is delightful to note that mutual fund are very well regulated by the Securities and Exchange Commission, one of the agencies of Finance Ministry.
They operate legally and are bond to the law which demands that they should not only register with Nigeria’s Securities and Exchange Commission (SEC), but that all investors should have a prospectus.
So, the investors are in the know as touching vital information like the fund’s history, cost structure, and so on.
It should also be added that these funds make use of a standard bank in the country that acts as the custodian of all the pooled resources.
They must even operate with a trustee too. Therefore, as an investor, you can comfortably invest in mutual fund, knowing that the risks have been reduced to the barest level.
Predictable Price:
It is easier to predict price movements of mutual fund. This is one of the major benefits of this even over individual stock. Hence, you have time to make crucial choices.
Safe investment Vehicle:
A big selling point of a mutual fund is the fact that they present a safe way of investing. In fact, they usually work with an independent trust company to hold and account for all the resources and assets in the fund. Your interests as a unit holder are well secured.
Disadvantages of Mutual Fund
Well, actually, mutual funds have their own disadvantages. Some of which include
Dilution:
As you should know already, diversification is one of the major strengths of mutual funds. However, dilution makes it a disadvantage on the other hand.
So, let’s say a particular stock purchased by the fund should double in value, you will be amazed that it won’t have a big impact on the entire fund, because the stock is only a small part of its holdings.
Fees and Expenses:
It is usual for the handlers to charge management and operating fees. Also, some of them go-ahead to charge high sales commissions as well as other fees (like redemption and the likes). The implication is that, there are times the transaction costs add up significantly and become a big deal.
Loss of Control:
The handlers of these funds are the ones to decide on what to do and what not to do. You as an investor simply have to helplessly sit back and watch them do whatever it is that they desire – it doesn’t matter if you have an opinion or not.
Deposit Insurance:
Kindly note that even if a scheme is regulated by the government, it can still bring losses to investors. This is the case with mutual funds. You can still end up losing some of your resources.
Trading Limitations:
While mutual funds are greatly liquid, investors can’t go on buying or selling in the middle of the trading day, but must patiently wait till the end of the day.
This is so because mutual funds have been structured to have their current value calculated at the end of the day.
Conclusion
While a mutual fund is not a utopian investment option, it is greatly ahead of several others, particularly if you want something that minimize the risks of losing your investments.
It accommodates different types of investors irrespective of what their investment style and financial strength and goals are. You don’t have to wait till you have all the money in the world before you can start to invest.
Sources:
- Featured image by pixabay
- Nigerian Exchange Group. “Mutual Fund”. ngxgroup.com
