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What
You Should Know About Mutual Funds
What is a mutual fund?
A mutual fund is a company that pools the money of many
people and institutions and invests it in stocks, bonds, or other
securities to pursue a specific financial objective. Professional
money managers make the day-to-day decisions about which stocks,
bonds, or other securities to buy and sell. Each investor shares in
the fund’s gains or losses according to how many shares they own.
Mutual funds can be categorized as money market funds, stock
funds, corporate and government bond funds, municipal or tax-free
bond funds, and balanced funds (which own both stocks and bonds).
Within these categories there are specific types of funds. For
example, stock or equity funds range from the conservative growth
and income funds to the more aggressive small company and
international funds.
What are the advantages of investing in mutual funds?
Diversification: Mutual funds can help reduce your
risk of loss. By owning several investments you lessen the chance
that you’ll suffer if one or two of them drop in value. Achieving
diversification on your own can require more money and effort than
you may be able to provide. One mutual fund can hold dozens or even
hundreds of different securities at the same time.
Professional management: Your investments
are handled by financial experts who spend all day every day
managing investments. These experts have investment experience and
are backed by analysts who conduct extensive research on individual
companies as well as entire industries. Wright has been researching
and managing investments for 40 years. Money management has long
been available to large companies and wealthy individuals. Mutual
funds make this financial expertise accessible to everyone.
Liquidity: your money is within reach. You can
usually sell your mutual fund shares on any business day - unlike assets that can't be sold early without penalties like a
certificate of deposit, or which take time to sell like real estate.
Of course, share prices fluctuate so you may end up selling your
shares at more or less than the original purchase price.
Convenience: you may conduct your business over
the telephone, through the mail, or on the Internet. After your
initial purchase, many transactions can be made with a telephone
call. You can make your investment program even more convenient with
the automatic investment plan or systematic withdrawal plan.
Dividends and distributions may automatically be reinvested.
What are the risks of investing in mutual funds?
All investments involve risk. That is the difference between
an investment account and a savings account. Generally speaking, to
achieve greater rewards - such as a higher investment return - you
must be willing to assume greater risk. And conversely, to minimize
risk, you must be willing to accept lower returns.
Bonds are often safer than common stocks. The trade off? The
return potential for a bond fund is lower than that of a fund which invests in stock. The common stock of smaller companies is riskier
than the stock of larger, more established companies. However, the
common stock of smaller companies may offer more potential for
growth. The trade off? Mutual funds that invest in smaller companies
are often more volatile than those which invest in the common stock
of larger companies.
The table below shows the different types of funds and the
potential risk/return trade off.
|
Lower risk and return |
Moderate risk and return |
Higher risk and return |
|
Money market funds |
Short- and intermediate- term bond funds |
Long-term bond funds |
Balanced funds |
Growth and income funds |
Growth funds |
Aggressive growth funds |
Setting your financial goals and objectives
Knowing your tolerance for risk is one of the important issues
you must consider when you are making an investment decision. You
must have a strong understanding of your personal situation and
investment goals. Consider the following criteria when developing
your investment strategy.
- Current income needs:
Do you need income from your
investment to meet current living expenses? Will you reinvest any
dividends or interest paid that exceed your current income needs?
- Capital risk tolerance:
Will you be seriously concerned
over a temporary drop in market value or your investment?
- Time horizon:
How long can you invest before withdrawing
substantial funds? Will you need to withdraw money for a new car,
tuition, or a vacation home?
- Tax liability:
Are you in a high tax bracket? Are you
subject to a state capital gains and dividend tax?
- Legal considerations:
Are there investment restrictions
due to the nature or source of your funds? Are the funds part of
an organization or other entity on which investment restrictions
have been imposed by law or other regulations?
- Liquidity requirements:
Is there a foreseeable need for
large amounts of cash for which provisions should be made?
- Unique requirements:
Is there anything unique or special
that must be considered in your financial planning?
These factors affect how much risk you can tolerate and what sort
of investments you should consider. Generally, the longer your time
frame to invest, the more risk you can afford since time allows you
to ride out market cycles. Just remember that there is no foolproof
way to accurately gauge your risk tolerance.
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Is Wright Investors' Service? |
