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What are Mutual Funds? What are they made up of?

6 Mins read

“What are mutual funds?” This is a question we get asked every other day in Cowrywise.

In this article, I’ll use my love for Ice Cream to break down exactly what this concept means. 

Before we dive in though, please, do me a favour. After reading this article, kindly leave a comment saying “I understand mutual funds better now”. It’ll help me know that this was simple to digest. And if you have any questions, feel free to leave them in the comments too.

So what are mutual funds? 🧐

Mutual funds are a type of investment that allows you to invest in different types of assets at once while allowing you to be as hands-off as possible with paperwork and other intricacies. It’s a basket of different investments put together to form one asset group. That asset group is called the mutual fund and the professionals who put the different investments together are fund managers.

Who are fund managers?

Fund managers are investment experts who work as professional asset managers to help meet specified investment goals on behalf of investors. They use their expertise and experience to determine what a mutual fund should comprise and how a fund should be invested profitably.

Back to mutual funds, let me break it down with ice cream.

How I like my Ice Cream 🤤

Instead of buying 4 cups with just one flavour in each, I prefer to buy a cup with different flavours and toppings in it. I never buy strawberry, vanilla, cheesecake and my absolute favourite chocolate flavours in 4 different cups. I buy the biggest cup or cone and then put all my favorite flavours in it with any topping I’m craving at the time.

Investing in a mutual fund is like that. It’s a simple way to diversify without the hassle of buying and managing the assets one after the other. A fund manager does the “hard work” of putting different assets together; you then buy shares from the “basket”. Simply put, a fund manager brings together cash from multiple investors, and uses the bulk amount to buy carefully selected assets.

With mutual funds, you’re diversifying in a quick way but only buying one thing. 

You’re investing in bits of everything. Just like enjoying different ice cream flavours in one cone! 😋

Understanding the different risk levels 📊

Mutual funds are universally separated into three risk levels: low, medium and high risk. You’re advised to stick to certain types of mutual funds, depending on your risk profile as an investor.

When you invest in equity mutual funds (Aggressive Funds), what you’re investing in are company stocks. So you’re buying a piece of companies like GTB, Access, Nestle, Dangote, MTN, Total, etc. 

While when you invest in conservative funds (low-risk funds), you’re investing in low-risk instruments like treasury bills, bank deposits, commercial papers, bonds, call cash. 

When you then invest in balanced (medium-risk) funds, you’re investing in a mix of both high-risk funds and low-risk funds. 

Back to ice cream flavours. Let’s say regular flavours like strawberry, vanilla and chocolate are conservative. They’re for people who don’t like to explore or try out “new things”. It means that your cone here will only have these flavours that promise you a certain taste back.

But high-risk flavours are flavours like mint, buttered pecan, and cookie dough because they can taste great today and taste really bad tomorrow. So they’re for adventurous people.

Investing in medium risk assets is you then buying a mix of chocolate and buttered pecan in your cone. You’re in the middle, like the people who eat Jollof rice with stew. Did someone say trust issues? Ok ok, moving on!

Can you explain the risk levels to me? 🤔

Of course!

Aggressive Funds: They contain a higher mix of stocks and are usually called high-risk funds. 

For example, the ARM Aggressive Growth Fund is made up of 79.59% equities and just 20.41% of fixed income instruments. If the percentages were vice versa, this would have been a low-risk fund because it’ll have a higher percentage of conservative instruments.

Anyway, when you go deeper into the assets under the ARM Aggressive Growth Fund, you find that it is spread into the Banking, Consumer Goods and Industrials industries. When you go even deeper again, you find that it has companies like MTNN, NESTLE and DANGCEM in its portfolio.

So when you invest in this specific ARM fund on Cowrywise, you get shares in MTN and NESTLE without having filled long forms or stood on queues.

Balanced Funds: These are usually referred to as medium risk funds and they contain a mix of stocks and low-risk instruments like bonds and money market 

Conservative Funds: They’re usually called low-risk funds and contain assets like treasury bills, bank deposits, commercial papers, bonds, and money market instruments.

Who are mutual funds for? 🧐

Mutual funds are for investors who have money but don’t want to do the stressful work of investing in separate assets and managing the paperwork of buying each, one by one.

They’re great for first-time investors or people who just want a more seamless investing experience where the fund manager is in charge of managing the performance of the fund.

If you’re to create your own mutual fund, you’ll have to personally go buy Total stock, buy GTB stock, buy treasury bills, bonds, then manage the performance of the mix of all these yourself.

By investing in mutual funds, you give your money to a fund manager and ask them to invest it in various financial instruments for you.

What are mutual funds?

What are the pros and cons of mutual funds? 📝

Pros

Provides Options

In life, having options is crucial. On Cowrywise alone, there are over 20 types of mutual funds available for you to choose from. Each one has a different investment strategy and risk level and anyone can find one that meets their investment needs.

Professional Management

Fund managers are the professionals in this case and they know a lot about putting various assets together. You don’t need to worry about buying shares in the nick of time or watch closely on a daily basis to balance your portfolio out. That’s the job of the fund manager.

Inexpensive

One of our major goals at Cowrywise is to give retail investors access to profitable investment opportunities and mutual funds are the major way we get that done. Mutual funds allow you to start investing with what you can afford while you work to grow your assets. They’re one of the most inexpensive ways to invest in a diversified portfolio.

Diversification

As stated earlier, you’ll have to do a lot of work to build a diverse portfolio without mutual funds. By investing in one mutual fund, you can easily diversify your investment into different asset types.

Easy to convert to cash

If there’s a need for quick cash, you can easily sell your shares in mutual funds. They’re also very easy to buy.

Generally low risk

Investing in mutual funds generally comes with less risk of losing all your capital, compared to investing in stocks or cryptocurrency directly. The stock and crypto market is much more volatile and not really for the faint-hearted.

Cons

Fund manager fees

Fund managers in Nigeria usually charge between 1% to 2% to manage mutual fund investments and this can be a turn off to some investors. However, when comparing this to the work a new investor will have to do themselves, this is a little price to pay. The middlemen in any sector have to make some profit and it’s no different in investing. 

Little Control Over Your Portfolio

With mutual funds, you have to rely on fund managers to create the mix that will make up your portfolio and you also rely on them to make informed decisions. You can’t decide to invest more in a particular asset except you buy mutual funds that have more of those kinds of assets.

Now that you have answers to the “What are mutual funds?” question. What should you do next? 👏🏽

I could end this with a lot of aspire to perspire but I’ll be straightforward and say – start investing in mutual funds now.

When you start early, you learn much more than the person who’s sitting on the sidelines. There are insights about investing you can never learn until you actually take action. You can choose from the more than 20 options on Cowrywise right now.

Cheers to your success! 🥂

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