Mad Rich

A mutual fund is a collection of stocks and bonds. It can be considered as a company that collects a group of people and invests money of these people in stocks, bonds and other securities. Every investor owns shares and these represent a part of the holdings of the fund.

Earning money

Money can be earned from a mutual fund in three modes. Income can be earned as dividends on stocks and interest on bonds. The income received throughout the year is paid by the fund to fund owners in a form of a distribution. Secondly, if the fund sells securities that have raised in price, the fund has a capital gain. Many funds pass these profits to investors in a distribution. Thirdly, the fund holdings may rise in price, but may not be sold by the fund manager. Then the fund’s shares rise in price. These funds can then be sold for a profit. Funds also offer two choices – to get a check for distributions or to reinvest the earnings and buy more shares.

Advantages

One advantage is of professional management. The investors buy funds as they do not have the time or expertise to handle their own portfolios. A mutual fund is a less costly method for a small investor to have a full time manager to monitor the investments. Another advantage is of diversification. Rather than owning individual stocks and bonds, if shares are owned in a mutual fund, the risk is decreased. The tactic in diversification is that if the investment is in different assets, the loss in a particular investment is compensated by gains in other investments. Large mutual funds own hundreds of different stocks in varying industries. It isn’t possible for an investor to make such a portfolio by a small quantity of money.

A third advantage is of economies of scale. A mutual fund buys and sells large amounts of securities at a time. Thus, the transaction costs are much less than that for an individual for securities transactions. The fourth advantage is of liquidity. Similar to individual stocks, a mutual fund permits that the shares be converted to cash at any time. The fifth advantage is of simplicity. Many companies have an automatic purchase plan where an amount of $100 can be invested on a monthly basis.

Types

Equity is a stock or security that represents an ownership interest. The company’s balance sheet consists of the amount of funds contributed by the stockholders and the retained earnings or losses. In terms of margin trading, equity means the value of securities in a margin account minus that which had been borrowed from the brokerage. Fixed income security is an investment that has a return in the form of fixed periodic payments. There is also an eventual return of principal on maturity. The payments of a fixed income security are known in advance. Money market securities consist of federal funds, municipal notes, commercial paper, U.S. Treasury bills, bankers acceptance, negotiable certificates of deposit and repurchase agreements. This is used by participants for borrowing and lending in the short term, from some days to less than a year.