DEFINITION OF 'MUTUAL FUND'
An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.
DHANVARSHA EXPLAINS 'MUTUAL FUND'
One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes expressed as NAVPS.
How to buy mutual fund
When choosing mutual funds, few aspects are within investors' control. Future performance isn't one of them. But expenses, risk, manager tenure and tax-efficiency are qualities that can be judged before you buy.
Index funds, which track a basket of stocks, are generally low-cost options intended to provide market-like returns. Active management, in contrast, relies on a professional's stock-picking in an effort to beat a market benchmark.
Here are the major pitfalls that can trip you up with mutual funds:
Paying too much: It can't be said enough: with funds, costs matter. Annual expenses eat into total return, year after year. With high-cost funds, you pay more and pocket less. Moreover, studies show that low-expense funds are more likely to outperform their costlier counterparts over time.
Taking excessive risk: Funds with great multiyear track records may look attractive, but you need to know just how those returns were generated. Check the fund's annualized results for unusual highs and lows. Then compare those figures with its category peers.
Portfolio overlap: Don't be a fund collector. Copycat funds bloat your investment portfolio and drag down performance. At some point, the blend will produce bland, index-like results at a high cost. Plus, heavier concentration in a few stocks adds risk.
Recent manager changes: A fund's performance doesn't always speak for itself. Funds are ranked, rated and rewarded on the strength of returns over several years. But if a manager is new, those results are no longer a litmus test.
Investment strategy drift: A burst of trading activity, venturing into new market sectors, adding larger-cap stocks, taking an aggressive stance in a volatile market -- these are all telltale signs that a fund has changed its investment strategy, and not always for the better.