As a new investor, you may have come across the term “mutual fund” or even heard some things about it but still wondering how it works. In this comprehensive guide on mutual funds for beginners, we demystify everything you need to know to begin your journey as a mutual fund investor. Keep reading.
In this article:
- How mutual funds work
- Types of mutual funds
- Why you should invest in mutual funds
- Things to consider as a mutual funds beginner
- Risks of mutual fund investing
- Investment costs/fees for mutual funds
- Fund managers
How mutual funds work
Mutual fund is a pooled investment vehicle. This means rather than buying single stocks, you and several other investors take your money and put it into one place.
Then, with the help of an investment or fund manager, the money is designated into a collection of stocks, bonds, and other securities.
You most likely cannot, by yourself, own a single share of stocks in hundreds of companies or say thousands of bonds. However, by purchasing units of a mutual fund that holds all these securities, you can.
Fund managers, because they pool the funds from all their clients, can purchase all those investments on your behalf.
To sum it up, mutual funds give both small and big investors access to professionally managed portfolios of stocks, bonds, and other securities.
Types of mutual funds
The majority of mutual funds fall into one of the following five categories: money market funds, bond funds, equity funds, target date funds and index funds.
Each has distinctive features, risks, and benefits. Let’s briefly discuss some of them.
1. Money market funds
Money market funds have comparatively low risks. This is because they only invest in a select group of high-quality, short-term securities issued by corporations and the government.
2. Target date funds
Bonds, stocks, and other investments are all mixed in target date funds. The mix gradually changes over time in accordance with the fund’s strategy. Lifecycle funds, also referred to as target date funds are created for people with definite retirement dates.
3. Equity funds
Equity funds, also referred to as stock funds, invest in business equities. Not all stock funds behave the same. Some equity funds are named according to the size of the companies they invest in such as small-cap, mid-cap, large-cap or multi-cap equity funds.
Others are named by their investment approach such as growth-focused, income-oriented, etc. Growth funds, for instance, concentrate on stocks with the potential for above-average financial returns but may not pay regular dividends.
Learn more about investing in equities.
4. Bond funds
Bond funds invest mainly in bonds. They often strive to earn better returns; therefore, they have higher risks than money market funds. The risks and returns of bond funds can vary considerably because of the diverse range of bonds.
5. Index funds
An index fund is considered to provide low operating costs, broad market exposure, and minimal portfolio turnover. Regardless of the status of the markets, these funds tend to keep to their benchmark index.
Why you should invest in mutual funds
Here are some reasons you should invest in mutual funds:
Although some mutual funds are expensive, most mutual funds are cheap and beginner-friendly. Compared to other stocks, mutual funds have a small entry amount you can start investing in.
In addition, because you are pooling money with other people, it gives everyone in the fund a buying power that you wouldn’t get individually. Remember the saying “there’s strength in numbers.”
Investing is taking a risk, which is why it is advisable to invest in multiple assets.
However, investing in multiple assets as a beginner can be tricky; this is why mutual funds are the most recommended for beginners because they come diversified.
Besides getting returns from multiple companies, a diversified portfolio gives you more confidence in your investment journey.
Your investment goes into hundreds of companies and stocks, which means there’s a low chance of you recording losses if there’s a decline. Although some companies may record losses, other companies will record gains.
Your investment compounds when your dividends and other interest earnings are reinvested into the mutual fund; you leverage your returns to purchase more units.
As an investor, if you have a pressing financial need, mutual funds are liquid enough for you to sell the units and get the funds in the next day or two.
The returns could be low though especially if the assets were liquidated when the fund is currently experiencing a loss. However, because of diversity, mutual funds’ value swings are generally less erratic, making them less volatile.
Things to consider as a mutual funds beginner
Before plunging into the stock market, every beginner should do thorough research just like you are doing by reading this article. Know the different types of mutual funds and their pros and cons. If you can, reach out to a financial advisor for more tailored advice.
Know your goal
What goal are you investing towards? Are you looking to build wealth or make quick bucks? While mutual funds can help you build wealth, you need patience, regularly topping up your investment and allowing your returns to compound over the years.
Identify your risk tolerance
The amount of loss an investor is willing to take on when making an investment decision is referred to as risk tolerance.
Investors are typically divided into three basic types depending on how much risk they are willing to take: Aggressive, Moderate, or Conservative.
Are you okay with losing money, or are you conscious about it? You need to understand your risk type and personality before deciding to try out mutual funds as a beginner.
Find out your risk tolerance by taking our risk assessment test.
If you decide to exit the investment within just a few days of investing or before the investment has even done anything substantial, you might be charged an exit load fee. This doesn’t apply to every mutual fund.
Risks of mutual fund investing
Returns might be low
You may make less with mutual funds than you would if you decide to invest in a single stock (provided the stock performs really well), especially if you invest the very minimum.
One of the key benefits of a mutual fund that is frequently mentioned is diversification. However, there is always the possibility of over-diversification, which could raise a fund’s running costs and erode the relative benefits of diversification.
You are not fully in control
This is a pro and a con. If you are someone who likes to monitor the market actively, then you should have fewer mutual funds because the fund managers are in charge and not you.
Any mutual fund’s performance is based on the manager’s experience, knowledge, skill, and investment techniques/processes. If any of these factors are lacking, it will negatively impact the fund’s performance and hurt unit holders.
In response to specific occurrences such as general economic and market conditions, regional or global economic instability, or currency and interest rate fluctuations, the prices of or income generated by companies’ assets may decrease.
Learn about other general types of risk in investment.
Investment costs/fees for mutual funds
The majority of mutual funds require a minimum investment of a few naira or dollars before you can opt-in to buy shares or a fixed amount of the fund.
If an investor invests N1 million with a fund manager and the fund charges a 1% management fee annually, the investor will pay N10,000.
Depending on the fund design, such fees may be due monthly, quarterly, or annually. With quarterly payments, in this case, the N10,000 is distributed over four quarters at the cost of N2,500 each.
Who are fund managers?
A fund manager is a qualified individual who has a proven track record of managing investments and a comprehensive understanding of markets.
The annual cost paid by the fund houses to manage the mutual fund is known as the expense ratio.
A fund manager’s role is one of the most important aspects of investing in mutual funds because they are the ones that actively manage the entire investment portfolio.
They decide where to invest, monitor the growth and performance of a fund, as well as protect the wealth of investors.
Watch this fun video on how mutual funds work:
How to begin investing in mutual funds
With Cowrywise, you can begin investing from as low as N1000 for Naira mutual funds and $10 for Dollar mutual funds.
- Download the Cowrywise app here
- Create your account or sign in to your existing account.
- Tap “Invest”
- Then, choose your preferred mutual funds option
- The rest is easy-peasy lemon-squeezy.
Congratulations, you are now a mutual fund investor. 😉
Mutual funds FAQs
Do you have more questions about investing in mutual funds on Cowrywise?
Starting your investment journey may seem intimidating, especially as you have seen several terminologies thrown around. However, as you get started and understand more about investments, investing will become a healthy habit that helps you build wealth.
Before choosing the best fund to invest in, you should consider the factors mentioned above. Additionally, you’ll need to keep an eye on your fund’s performance and make adjustments as and when necessary.
Follow these links to learn more about some new terminologies you may have just encountered: