Mutual funds are a type of security that is traded on the stock market, enabling shareholders to purchase and sell shares in the funds as they choose.
The money that is raised by the purchasing of shares by shareholders is utilized by the investment company that created the firm to purchase more shares of certain stocks, bonds, and other market securities and money market instruments.
A mutual fund can make money from its securities in two methods: a
security can pay dividends or interest to the fund or a security can
increase in value. And a fund can also lose money and drop in value.
There are three basic types of mutual funds:
- Stock: Stock mutual funds are investment done primarily in purchasing shares of stock issued by U.S. or foreign companies.
- Bond: Bond mutual funds invest primarily in bonds.
- Money market: Money market mutual funds invest mainly in short-term securities issued by the U.S. government and its agencies, U.S. corporations, and state and local governments.
Stock Mutual Funds
Stock funds invest primarily in stocks. A share of stock signifies a unit of ownership in a company. Shareholders can profit in two ways if a company is successful, which includes:
There may be an increase in the price of the stock, or the company can pass its profits to shareholders in the form of dividends. A shareholder can lose the entire value of his or her shares if the company fails; however, a shareholder is not liable for the debts of the company.
Bond Mutual Funds
Bond mutual funds are the investments done primarily on securities known as bonds. A bond is a type of security that resembles a loan. The company, municipality, or government agency that issued the bond is borrowing money from you when a bong is purchased.
The issuer promises to repay the amount loaned on a specific maturity date in return for the use of this money. Additionally, the issuer usually promises to make periodic interest payments over the life of the loan.
A bond mutual fund share represents ownership in a pool of bonds and other securities comprising the fund's portfolio. Even though there have been past exceptions, bond funds tend to be less volatile than stock funds. They often are a regular source of income.
Therefore, investors often choose mutual bond funds to diversify, provide a stream of income, or invest for intermediate-term goals. Like stock funds, bond funds too have some risks and can make or lose money.
Money Market Mutual Fund
A money market fund is the investments done on short-term, interest-bearing securities. A money market instrument is a short-term IOU issued by the U.S. government, U.S. corporations, and state and local governments.
The maturity date of money market instruments is of less than 13 months. These instruments are comparatively stable because of their short maturities and high quality.
Money market mutual funds are a great alternative, for the less affluent investors, to Treasury bills and certificates of deposits. This is because money market mutual funds require less money to be paid out up front.
Treasury bills often require thousands of dollars to begin investing. Money market mutual funds are extremely popular, due in part because of their liquidity. This type of fund acts much like a savings account.
Advantages of mutual funds
Mutual funds can be an attractive choice for both new and experienced investors for a the following reasons:
- Affordability: You can open a mutual fund account for as little as $1,000, and add to it in even smaller amounts. In some cases, you can even invest as little as $50 a month if you arrange for an automatic transfer funds from your checking or savings account into your fund account.
- Diversification: You're investing in all the different stocks or bonds the fund owns by buying shares in a mutual fund. Owning many investments in place of just a few can help protect you against losses you might have if the ones you'd selected happened to fall in value.
- Liquidity: By selling your shares back to fund, you can easily convert your shares into cash at any time. Fund's net asset value (NAV) determines the selling price, which may be higher or lower than the amount you originally paid for the shares.
- Professional expertise: Each fund is run by a professional manager who makes all buying and selling decisions.
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