Mutual funds have become the go-to investing choice among investors and especially those at the very beginning stage of investing. It is no wonder that mutual funds continues to draw the biggest pool of investment with the ETF industry still having miles to go before it can give the mutual fund industry any sort of competition.
“Mutual funds were created to make investing easy, so consumers wouldn’t have to be burdened with picking individual stocks. ” Scott Cook
Mutual funds have no doubt created wealth for retirees and generally conservative investors with the rise in stock prices.
This article throws light on:
- What factors push investors to opt for mutual funds?
- What are the risks involved in investing in mutual funds?
- Who regulates mutual funds?
What factors push investors to opt for mutual funds?
An investor is not new to mutual funds, especially if they have been around investing in stocks for a while.
Mutual funds have become more popular for a number of reasons. From the ease of investing and low entry requirements to the longest bull-run in the equity markets, which has managed to weather some big geo-political events such as Brexit and the U.S. elections that led to a surprising Donald Trump victory.
At the outset mutual funds have created wealth for retirees and general safe financial players with the rise in stock prices. But why invest in mutual funds and why is investing in mutual funds a popular option?
How beneficial are they and what are the risk factors involved in mutual funds investing? After all they are also a kind of instruments of investments.
Why should you invest In Mutual Funds?
If you are considering investing in the stock market and are afraid of its somewhat unpredictable fluctuations, you can definitely consider investing in mutual funds.
The biggest factor that works in the favor of mutual funds and indeed are the selling points is that mutual funds are lower risk compared to an investor individually picking stocks. This is because mutual funds are like a package of stocks and more importantly, they are well diversified so they can absorb the shocks of the stock market better than the individual stocks themselves.
As with the risk, the costs of unit share too are spread across making them affordable by almost any one.
If you are looking at open end funds you can always purchase them from the company at the NAV minus some loads or expenses. The closed end funds give you the flexibility of independent stocks while combining the best of the features of mutual funds.
How can mutual funds be used to manage risk?
In order to efficiently manage risk, mutual fund managers allocate the available funds in certain proportions among the various assets where they are going to invest. This is based on the risk assessment of the asset itself.
So, for example if an asset is known to be very volatile, it will be given a smaller capital allocation, while a stock which is known to be steady and stable will be given a higher allocation.
It is not just capital allocation and distribution but also the portfolio diversification that helps to play a role in mitigating any risks. Consider a fund being well diversified across the spectrum of exchange listed stocks and bonds which yield a guaranteed return in addition to being invested in money markets and real estates.
While bonds and money market investments provide a slow but steady return, other instruments are of high yielding character in a short period. The higher risk of high yielding portfolio is compensated for by the investments in bonds in events of adverse market behavior.
The portfolio will be constantly reviewed and adjusted to variations in order to maximize returns and minimize risks. This means, fund managers buy or sell stocks or bonds as per the dictates of the fund and market pulls. For example an investment in a perceived risky instrument will be sold immediately and reinvested in a prospective media of the time.