What are Mutual Funds?
A mutual fund is a pool of money professionally managed and invested in specific types of securities. The manager of a mutual fund is guided by strict regulations. However, they monitor the value of the investments very closely so that they can maximize the earnings of the fund, while operating within the fund's objective and guidelines. A good investment manager should outperform the usual alternative investments available mostly to big investors.
Advantages of Mutual Funds
The money accumulated in a mutual fund is managed by professionals who decide on behalf of the shareholders on investment strategy. These professionals choose investments that best match the fund's objectives as described in the prospectus. Their investment decisions are based on extensive knowledge and research of market conditions and the financial performance of individual companies and specific securities.
Fund managers typically invest in a variety of securities, seeking portfolio diversification.
A diversified portfolio helps reduce risk by offsetting losses from some securities with gains in others. The average investor would find it expensive and difficult to construct a portfolio as diversed as that of a mutual fund. Mutual funds provide an economical way for average investors to obtain the same kind of professional money management and diversification of investments that is available to large institutions and wealthy investors.
Liquidity is the ability to readily convert investments into cash. Other investment products require investors to find a buyer so that he can liquidate his investment. That is not the case with mutual fund shares because the fund itself stands ready to buy back these shares at the prevailing Net Asset Value Per Share. While the law provides that the redemption proceeds must be given within seven (7) banking days from the date of the redemption request, most funds are able to pay the redemption proceeds with 2 to 3 days. Mutual funds are, therefore, considered very liquid investments.
Mutual funds are highly regulated by the Securities and Exchange Commission (SEC) under the Investment Company Act and its implementing rules and guidelines. They are prohibited from investing in certain investment products and from engaging in certain transactions. They also have to submit regular reports to the SEC and the shareholders as well.
Mutual funds must calculate the price of their shares every business day. Investors can sell (redeem) some or all of their shares anytime and receive the current share price, which may be more or less then the original price.
Mutual fund shareholders are part owners of the fund and are therefore entitled to vote during the funds' annual shareholders' meeting.
Potential Higher Returns
Because a mutual fund is managed as a single portfolio, it is able to take advantage of certain economies of scale. For instances, with its millions or billions under management, it can negotiate for lower stockbrokerage fees or command higher interest rates on fixed-income investments.
Income generated by mutual fund shareholders are exempted from capital gains tax as stipulated in the Comprehensive Tax Reform Program.