Investment in Mutual Fund

A mutual fund is an investment vehicle in which a pool of investors collectively put forward
funds to an investment manager to make investments on their behalf. The fund is regulated by
the Securities Exchange Commission, or SEC.

When involved with a mutual fund, each investor benefits proportionally to the amount of
money they invested. Mutual funds may invest in stocks, bonds, money market instruments,
or other assets.

Depending on the vehicle of investment and redemption patterns, mutual fund investment can
offer tax benefits.

The advantages of mutual funds are the ability to diversify a portfolio across industries, low
fees, and availability of professional expertise in the guise of fund managers.

The disadvantages of mutual funds are that they do not provide ownership of underlying
holdings to investors; hence, investors do not have much say on the composition and
constituents of mutual funds.

Mutual funds are also more expensive and riskier as compared to index funds.

Have questions about Mutual Funds? Click here.

Basics of Mutual Funds

Mutual funds can be a good opportunity for small or individual investors to benefit from a
professionally managed investment portfolio.

They usually invest in a large number of securities, and their performance is tracked as the
change in the market cap of the fund, which itself is determined by the performance of the
underlying investments.

Mutual funds charge a sales commission, known as load, as well as management fees related
to the fund’s administration. While all funds charge management or administration fees, there
are funds in the market that are no-load, meaning they do not charge a sales commission.

The returns of a mutual fund are based on the performance of its constituents. Therefore, skill
and expertise is required to pick equities that provide desired returns. Highly-trained
professionals function as fund managers for mutual funds.

You can use fund rankings issued by research firms like Morningstar and Standard & Poor to
select funds. Buying shares of a mutual fund does not give investors voting rights in a
company; instead the fund manager votes on their behalf.

However, since mutual funds generally incorporate hundreds of different securities, it does
give investors the benefit of diversification of their portfolios.
 Investment in Mutual Fund
The value of a share of mutual fund is called the net asset value per share, or the NAV. The
price is determined by taking the net value of all the securities in the fund and dividing by the
outstanding shares.

Mutual funds can be open-ended or closed-ended. An open-ended mutual fund issues an

unlimited number of shares in the open market and redeems them at market value from
investors.

The share price of an open-end fund is based on the net asset value of its constituents.
Closed-end mutual funds function in the opposite manner i.e., they issue a fixed number of
shares and redemption is not allowed.

Instead, the only way for an investor to “redeem” a share is by selling it to someone else.

Therefore, their price is based on the dynamics of supply and demand and they always trade
at a discount to the net asset value of their constituents.

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 Investment in Mutual Fund

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Types of Mutual Funds
Broadly there are four types of mutual funds. They are as follows:

 Equity Mutual funds: Equity mutual funds consist of collections of stocks of

companies. Investors can allocate funds to funds based on their goals. For
example, growth funds are focused on stocks of companies with significant
growth potential in the future. Income funds include stocks of companies that
pay regular dividends.

 Money Market mutual funds: Money market mutual funds invest in short-term
debt issued by corporates, government, state, and municipalities. For example,
they might invest in US treasuries and debt issued by established companies
like Apple Inc. or Exxon. The aim of this type of mutual fund is to
generate income while minimizing risk.

 Bond funds: Bond funds are considered conservative investments and

provide fixed income to investors in such funds. Like money market mutual
funds, their investment portfolio is restricted to government and corporate
debt. They are generally favored for retirement planning.
 Investment in Mutual Fund
 Balanced Funds: Balanced funds aim to strike a balance between equity and
bond investing. They are long term funds that incorporate a mix of stocks and
bonds in a given ratio. For example, they might have 60% stocks and 40%
bonds. Rebalancing these funds on a periodic basis adjusts their composition
to prevailing economic conditions. Some are rebalanced based on the
investor’s goals. For example, they might incorporate a more conservative
approach close to retirement.

Tax Implications of Mutual Funds

The tax implications of mutual funds depend on the investment vehicle used to conduct the
transactions.

If mutual funds are traded from inside a retirement account, then capital gains accruing from
the sale are deferred.

If, however, the trades occur outside a retirement account, then the investor is responsible for
paying the prevailing capital gains tax.

Dividends from the mutual fund or redemption of units contained within the fund are
also taxed at regular rates for income and capital gains.

Pros and Cons of Mutual Funds

The benefits of mutual funds are as follows:

 Mutual funds are available in various flavors and help diversify a portfolio
across sectors and industries.

 Mutual funds enable regular investors, who do not have much knowledge
about the markets, to access sophisticated and professional expertise of fund
managers at low costs.

 Active mutual funds that take large positions in stocks can make a significant
difference to the performance of that equity and generate profits for investors
who hold shares in that fund.

 Mutual funds are a liquid market, meaning it is relatively easy to trade and
find a buyer for them. The same cannot be said for several assets.

The drawbacks of mutual funds are as follows:

 Mutual funds do not offer ownership of shares. Therefore, it is not possible for
investors to select or pick the composition of a fund to align with their values.

 Mutual fund fees can add up over time. According to 2016 research by the
Investment Company Institute (ICI), the after-fee return for $1,000 annual
investment averaging 7% return over 30 years for mutual funds is $86,000.
 Investment in Mutual Fund
Index funds offer $99,000 over the same timeframe due to lower management
fees.

 While they are a type of mutual fund, index funds have become more popular
in recent times as compared to regular index funds. This is because they are
cheaper and less risky. Unlike mutual funds, whose constituents are selected
with rigorous analysis, index funds stick to a tried-and-tested formula and
track indices.

 For those who hold very few units of mutual funds, returns can be negligible
or very low, especially when they are compared to similar equity investments.

Mutual Fund FAQs

What is a Mutual Fund?

A mutual fund is an investment vehicle in which a pool of investors collectively put forward
funds to an investment manager to make investments on their behalf. The fund is regulated by
the Securities Exchange Commission, or SEC. When involved with a mutual fund, each
investor benefits proportionally to the amount of money they invested.

What are the types of Mutual Funds?

The four types of mutual funds are: equity mutual funds, money market mutual funds, bond
funds, and balanced funds.

What are the pros and cons of investing in Mutual Funds?

The advantages of mutual funds are the ability to diversify a portfolio across industries, low
fees, and availability of professional expertise in the guise of fund managers. The
disadvantages of mutual funds are that they do not provide ownership of underlying holdings
to investors; hence, investors do not have much say on the composition and constituents of
mutual funds. Mutual funds are also more expensive and riskier as compared to index funds.

What are the tax implications of investing in Mutual Funds?

If mutual funds are traded from inside a retirement account, then capital gains accruing from
the sale are deferred. If, however, the trades occur outside a retirement account, then the
investor is responsible for paying the prevailing capital gains tax.

Does Mutual Fund ownership give you voting rights?

Buying shares of a mutual fund does not give investors voting rights in a company; instead
the fund manager votes on their behalf.
 Investment in Mutual Fund

AB O UT THE AUTHOR
True Tamplin, BSc, CEPF®
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True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of
Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial
Ratios Guide,