Investing in mutual funds is a popular investment strategy. A mutual fund is basically an open end, professionally managed investor managed investment fund that pools money from several investors to buy various securities. The investors in mutual funds pool their money together and decide what to invest in. The pooled money is invested in securities of different maturities and characteristics such as stocks, bonds, equity securities, and derivatives such as options, currencies, and futures.
Mutual funds can be broadly classified into two categories – common and specific. Common funds are usually pooled funds that buy and sell securities similar to those in a common category. Examples are funds that pool money into an aggressive portfolio that buys and sells stocks of oil and gas exploration companies. When the market changes, so does the portfolio manager who makes the necessary adjustments to protect the fund’s overall asset allocation.
On the other hand, specialized funds specialize in a particular security or a variety of securities. For example, hedge funds buy and sell financial instruments such as bonds, commodities, currencies, and securities in various countries. Hedge funds are managed by investment company specialists who have experience identifying profitable opportunities in the markets they analyze. As such, their decisions to invest in and out are based on their own years of experience in the markets they are involved in.
The primary advantage of investing in funds rather than individual securities is that they eliminate the additional costs of investment. Mutual funds usually pay administrative fees and commissions to the fund manager. This amount is typically quite low compared with the cost of each investment in securities such as stocks, bonds, and securities of undiversified nature (e.g., commodities). Also, investors are not required to provide a guarantee to the fund manager; this means that if the fund loses its value, the investors will not lose any money. Some funds also allow investors the option of selling securities at a discount.
As well as being less expensive, investors can diversify their portfolios by investing in mutual funds. This allows them to spread their risk across a wide range of different investments. For example, short-term investors who are looking to increase their chances of earning a profit by investing in a wide array of short-term investments may choose to invest their money in a diversified group of stocks and bonds, or invest a large amount of money in several small-scale companies. The advantage of investing in a group of securities is that large investors do not have to allocate all of their funds into just one type of investment. Long-term investors can diversify their investments by investing in long-term securities, either through buying individual securities, or by investing in a managed portfolio that has a number of long-term investment options.
Finally, these types of funds can help make an investor’s portfolio more stable. By pooling investments together and investing in similar securities, investors can ensure that the same risk-profile is being maintained. When a portfolio is made up of a number of different types of investments, there is the potential for losses due to fluctuations in the value of each security. However, with a managed fund, an investor will know exactly which securities are safe and which ones need to be sold to reduce the overall risk of the portfolio.