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Author: Sachin Asher Article source: http://www.articlealley.com/. Used with author's permission.
Each one of us does not have the expertise or the time to build and manage an investment portfolio. There is an excellent alternative available - mutual funds.
A mutual fund is an investment intermediary by which people can pool their money and invest it according to a predetermined objective.
Each investor of the mutual fund gets a share of the pool proportionate to the initial investment that he makes. The capital of the mutual fund is divided into shares or units and investors get a number of units proportionate to their investment.
The investment objective of the mutual fund is always decided beforehand. Mutual funds invest in bonds, stocks, money-market instruments, real estate, commodities or other investments or many times a combination of any of these.
The details regarding the funds' policies, objectives, charges, services etc are all available in the fund's prospectus and every investor should go through the prospectus before investing in a mutual fund.
The investment decisions for the pool capital are made by a fund manager (or managers). The fund manager decides what securities are to be bought and in what quantity.
The value of units changes with change in aggregate value of the investments made by the mutual fund.
The value of each share or unit of the mutual fund is called NAV (Net Asset Value).
Different funds have different risk - reward profile. A mutual fund that invests in stocks is a greater risk investment than a mutual fund that invests in government bonds. The value of stocks can go down resulting in a loss for the investor, but money invested in bonds is safe (unless the Government defaults - which is rare.) At the same time the greater risk in stocks also presents an opportunity for higher returns. Stocks can go up to any limit, but returns from government bonds are limited to the interest rate offered by the government.
History of Mutual Funds:
The first "pooling of money" for investments was done in 1774. After the 1772-1773 financial crisis, a Dutch merchant Adriaan van Ketwich invited investors to come together to form an investment trust. The goal of the trust was to lower risks involved in investing by providing diversification to the small investors. The funds invested in various European countries such as Austria, Denmark and Spain. The investments were mainly in bonds and equity formed a small portion. The trust was names Eendragt Maakt Magt, which meant "Unity Creates Strength".
The fund had many features that attracted investors:
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