Almost all financial blogs nowadays wax lyrical about the importance of investing, no matter what the scale might be. There is no denying that the secret to wealth is through smart and diversified investments, be it long term or short term; however, it might be difficult to know where to begin from especially if you previously had no interest in investing. Furthermore, most of the financial advice freely available on the internet is not specific to Sri Lanka, not taking into account certain important factors thereby not being entirely relevant. That being said, one of the universally-accepted investment truths is that mutual funds are one of the best ways to start your investment journey.
Let’s take a look at everything you need to know about investing in mutual funds.
What is a Mutual Fund?
A mutual fund is an investment instrument where a professional fund manager pools together money from various investors and invests this money across various ventures and securities, such as stock, bonds, money market and other assets. This fund manager operates the money as they see fit in order to get highest returns in a way that is in line with the mutual fund’s investment objectives. All gains and losses will be felt by all the shareholders of the fund. Investing your money in a mutual fund means you get ownership of one part of the fund, which might consist of various types of investments. Mutual Funds are usually categorised on the type of investments they comprise of e.g. equity funds, fixed income funds etc.
How can I earn money from Mutual Funds?
While mutual funds are not a means to get fast cash now, they are an investment instrument that can earn money for you in three different ways.
- Through dividends of the stocks you purchased as part of your mutual fund investment.
- Through price fluctuations of the stocks you purchased as part of your mutual fund investment (buy low, sell high).
- Through price fluctuations of the value of the mutual fund you invested in (buy low, sell high).
Why are mutual funds considered a safe investment?
Most financial experts advocate for mutual funds as being ideal for first-time investors due to multiple reasons.
Advantages of Mutual Funds
As all the investment decisions are taken by a professional fund manager or investment advisor who possesses the knowledge and expertise to make educated calls, a mutual fund is ideal for a first-time investor who has funds but no prior experience in investment.
A mutual fund is made of multiple investments across a number of avenues, thereby it is diversified by nature. A diversified investment portfolio means your risk is greatly reduced by not putting all your eggs into one basket.
Mutual funds can be bought and sold by investors relatively easily, making them quite a liquid investment. If you ever find yourself in a situation where you need cash today, you can sell your mutual fund slice and regain your money (at its value at the time of selling).
Compared to other types of investments, mutual funds tend to have lower fees and service charges for the investor. Additionally, mutual fund fees tend to be lower than the sum of the transaction fees of all the investments involved in the mutual fund.
Disadvantages of Mutual Funds
Due to owning a small part of many different investments that are all varying in value, your overall return on investments will be unpredictable, being the final sum of all the gains and losses of each avenue.
Dependent on Fund Manager’s Skill
Unfortunately, the profitability of a mutual fund is almost entirely dependant on the skill and knowledge of the fund manager. The investments decided by the manager at the price and time of their choosing will determine how well (or poorly) a fund performs. Furthermore, a fund manager still gets their money regardless of how the fund fares so a reckless fund manager might see you lose your money.
When should I avoid mutual funds?
While the attractiveness of mutual funds depends entirely on each mutual fund, you should consider whether a mutual fund is the correct investment for you. If you are looking for an investment that would get you fast cash now, perhaps a mutual fund is not the best match. While being quite liquid, you will likely not get a large payout in the form of cash today.
Additionally, if you don't have any disposable income at hand, perhaps investing altogether is not the best course of action to take. While there are many day traders who rely on money advances to buy and sell short-term shares using borrowed money, pocketing just the profits earned, mutual funds do not facilitate such a system. If you wish to earn money quickly and are looking to invest on borrowed money, mutual funds are probably not the best investment instrument for you.
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