Mutual Funds- What do Mutual Funds Do and How Do They Make Money?

Introduction

A mutual fund is a type of open-ended (investors can redeem their capital at any time they like) investment vehicle that invests in financial assets such as stocks or bonds by pooling capital from multiple investors.

Mutual funds are the biggest equity proponents in the U.S. Capital markets. Many individuals invest in mutual funds because it allows them access to a diverse portfolio of stock, bonds, and physical assets.

Every mutual fund has specific investment objectives highlighted in its prospectus. Every mutual fund offers a diversified portfolio, but some mutual funds might be invested in one type of security much more heavily than the other security.

The performance of a mutual fund is measured by the market capitalization of the assets in which the mutual funds invest. The mutual funds are managed by a professional money manager.

A mutual fund is a highly regulated financial industry in the U.S.A. This is due to the fact that many individuals with small net worth and retirement funds invest in mutual funds.

An example of a mutual fund is Primco Total Return; this mutual fund is managed by Bill Gross. It has about two hundred sixty-three billion dollars assets under management.

Types of Mutual funds

Their mutual funds are divided into four types and these are divided based on the types of assets that they invest in. The four main types of mutual funds are shown in figure 1 below:

Figure 1: Types of mutual funds

The four types of mutual funds are namely equity fund, bond fund, money market fund, and hybrid fund. All of these invest in different securities and assets. The classifications and details of every type of mutual fund are given below:

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Equity Mutual funds

Equity mutual funds are a sub-division of mutual funds that pool investor money to invest in the stock markets. They diversify their stock holdings to reduce risk and provide a well-diversified portfolio for their investors.

In the U.S. Mutual funds market, which is worth about eleven trillion dollars, about fifty-five percent of the Mutual funds invest in some kind of equity.

The equity mutual funds have a high potential growth as they invest in stocks, but they also have very high volatility. It means risk is magnified as returns are magnified.

So, the investors who are looking for more returns and can appetite more risks should invest in this type of mutual fund.

Bond Mutual funds

Bond mutual funds are the type of mutual funds that invest in Bonds. These mutual funds have traditionally invested in government bonds.

But, nowadays, due to the zero interest rate environments, these funds have also started investing in corporate bonds that have a higher yield than a government bond, they also carry a much higher risk.

Traditionally, bond mutual funds have been used by investors who do not have a great appetite for risk. They want their money to be invested in safe places. So, that is why they chose Bond mutual funds. These bonds carry a low-risk, low-return investment scenario.

Money market funds

These mutual funds are also called fixed-income funds. They invest mainly in short-term government bonds, treasury bonds, and certificates of deposits.

The money market mutual funds also invest in high investment-grade corporate bonds. They are considered a safe investment as they only invest in high-rated investment-grade bonds.

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The money market funds make up about fifteen percent of the total investment in the mutual funds in the U.S.A.

These funds are also great for investors who do not have a great risk appetite. So, these funds offer a low-risk and low-return investment scenario.

Hybrid mutual funds

Hybrid mutual funds are a type of combination of both bond and equity funds. They combine both the strategies of bond mutual funds and equity mutual funds.

These funds invest in both stock markets and government and corporate bonds. These are considered to be the most diversified type of mutual funds.

The returns offered by the hybrid funds are higher than the bond mutual funds but lower than the equity mutual funds. They also carry a higher risk than bond funds, but lower risk than equity funds.

So, they are in the middle of mutual funds in the risk and return columns. So, these types of mutual funds attract investors who want a higher return than the bond fund but do not want the volatility that is associated with equity funds.

What do the mutual funds do?

A mutual fund is basically a pool of capital that invests in a bunch of securities such as stocks, bonds, and C.O.D.

One of the biggest attractions of mutual funds is that they provide a diversified portfolio. This helps reduce the risk for the investors that are risk-averse.

How do mutual funds make money?

There are fees associated with mutual funds. Different types of mutual funds carry different fees.

When a person buys a mutual fund share, he/ she is buying a right to the future profits of that fund.

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Mutual means common and the mutual fund means that profits or losses are equally divided between every investor in the mutual funds who own the shares in the mutual funds.

Mainly, a mutual fund charges two types of fees. One is an annual fee called the expense ratio, which is a management fee and the other fee is a load fee which is charged when you buy or sell a mutual fund share.

The expense fee can be as much as 1% of your total investment and the load fee can be as high as 5.45%. These two types of fees are how mutual funds earn money.

Conclusion

Mutual funds provide a phenomenal opportunity for investors who want to own a diverse portfolio that will minimize risk, while also earning a great return on their investments. Mutual funds are one of the safest forms of investment.

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