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How to invest in Mutual fund for portfolio diversification

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Investors with keen interest to have returns on their investments need to boost their portfolio, in addition to investment in stocks, treasury bills and bonds, mutual funds also need to be considered.

This helps to diversify portfolio, through mixing bond funds with stocks funds, and including domestic and overseas funds, this entails rebalance funds annually to spread risk and avoid overexposure in any one area of the market, bearing in mind that, a fund’s past performance doesn’t necessarily indicate future success.

What is a mutual fund?
Investopedia defines Mutual fund as a fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets.

Author of complete idiot’s guide on investing’ Joshua Kennon, in his piece “Investing for beginners, the basics of mutual funds, what they are and how they can make you money” acknowledged that mutual funds are perhaps the easiest and least stressful way to invest in the market.

According to his report, more new money has been introduced into mutual funds globally during the past few years than at any time in history.

He however warned that before jumping into the pool and start throwing your money at mutual funds, you should know exactly what they are and how they work.

How mutual fund operate
Fund manager is hired to invest the cash the investors have contributed, and the fund manager’s goal depends on the type of fund; a fixed-income fund manager, for example, would strive to provide the highest yield at the lowest risk.

A long-term growth manager, on the other hand, should attempt to beat the Dow Jones Industrial Average or the S&P 500 in a fiscal year, very few funds actually achieve this.

Types of mutual funds
There are four types of mutual funds, they are closed vs. Open-Ended Funds, Load vs. No-Load

Closed-End Funds
This type of fund has a set number of shares issued to the public through an initial public offering.

These shares trade on the open market; this, combined with the fact that a closed-end fund does not redeem or issue new shares like a normal mutual fund, subjects the fund shares to the laws of supply and demand. As a result, shares of closed-end funds normally trade at a discount to net asset value.

Open-End Funds
A majority of mutual funds are open-ended. In a basic sense, this means that the fund does not have a set number of shares.

Rather, the fund will issue new shares to an investor based upon the current net asset value and redeem the shares when the investor decides to sell.

Open-end funds always reflect the net asset value of the fund’s underlying investments because shares are created and destroyed as necessary.

Load vs. No Load
A load, in mutual fund, is a sales commission. If a fund charges a load, it means that the investor will pay the sales commission on top of the net asset value of the fund’s shares.

However, No load funds, carries lower expenses and tend to generate higher returns for investors due to the lower expenses associated with ownership.

Benefits of investing in a mutual fund?
Mutual funds are actively managed by a professional money manager who constantly monitors the stocks and bonds in the fund’s portfolio.

Because this is his or her primary occupation, they can devote considerably more time to selecting investments than an individual investor.

This provides the peace of mind that comes with informed investing without the stress of analyzing financial statements or calculating financial ratios.

How to I begin investing in a fund?
If you already have a brokerage account, you can purchase mutual fund shares as you would a share of stock. If you don’t, you can visit the fund’s web page or call them and request information and an application.

Mutual Funds mainly invest in broad and diversified pool of investments. However these can be grouped into two;

A – Money Market, B – Capital Markets

Money Market – Example of Money Market instruments are Treasury Bills, Certificate of Deposits, Commercial Paper etc. These instruments are mostly debt note with a promise to pay a stipulated interest rates and the principal at a predetermined date.

Capital Markets – Capital Markets are markets where Bonds, Stocks (Shares) are traded on a daily basis. So, a Mutual Fund can also use your money to invest in stocks and bonds.

For example, when they invest in shares they hope that the value will appreciate thus increase the value of their fund or making them a nice profit when they sell the shares.

But please note, most mutual funds usually outline the type of investments they hope to invest your money in. This can be found in their prospectus.

How much can be invested?
Mutual Funds typically have an investment band depending on the nature of the fund. Some can be as low as a minimum of N5,000, whilst some can be N100, 000 and others N1, 000,000.

How profitable is mutual funds?
Like every other business Mutual Funds are also exposed to the same risk and rewards that can determine whether they make or lose money. But since no business originally sets out to lose money they will often tell you that they are profitable.

However, you can know how profitable a mutual fund is or can be if the fund owners already have a history.

Most of the managers already have experience in running funds and so must have track records of their performance in the past. It is also important that you look at what type of returns they intend to offer to their investors.

Returns from mutual funds?
mutual funds returns depends on the risk appetite of the investor. For example, if you have N100k and think you can invest it in any business of your choice and get a profit of N20%, then investing in a mutual fund that promises 14% returns may not be a good idea for you.

The return a mutual fund promises you should also be compared to returns one can get on risk free investments such as treasury bills etc.

For example, if a Mutual Fund promises a minimum return of 12%pa and Government Pays interest of 14% on Treasury Bills, then investing yourself may just be a better idea.

In general mutual funds will typically offer minimum returns that are benchmarked above inflation rates.

About the author

Ihesiulo Grace

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