Like most people, you may have a mutual fund or two invested in your retirement account. But do you know what a mutual fund is and what it invests in? We’ll break down the different types of securities mutual funds can invest in. So whether you’re just starting to invest or looking for a more diversified portfolio, read on for essential information.
What are securities?
To understand mutual fund investing, it’s essential first to understand what securities are. Security is a financial asset that can be traded in the market, and the most common types of securities are stocks, bonds, and cash equivalents.
When you buy a stock, you’re buying a piece of ownership in a company. That entitles you to certain rights, including voting on corporate matters and receiving dividends (a portion of the company’s profits). Stocks tend to be more volatile than other types of securities, which means they can go up and down in value more rapidly. But over the long run, stocks have historically outperformed other investments such as bonds and cash equivalents.
A bond is a debt investment whereby an investor loans money to a borrower (usually a government or corporation) for a fixed period. In return, the borrower pays the investor periodic interest payments.
Cash equivalents are short-term investments that are highly liquid and considered a shallow risk. Examples of cash equivalents include treasury bills, money market funds, and commercial paper.
What are mutual funds?
Now that we’ve discussed securities let’s turn to mutual funds. It is an investment vehicle that pools together money from many different investors and invests it in a portfolio of securities. They are managed by professional money managers who buy and sell securities to achieve the fund’s investment objective.
What do mutual funds invest in?
Mutual funds can invest in various securities, including stocks, bonds, cash equivalents, and other assets such as real estate and commodities. The type of securities a fund invests in depends on the fund’s investment objective. For example, if a fund’s objective is to generate income, it will likely invest primarily in bonds. If the fund’s objective is to provide capital appreciation, it will likely invest primarily in stocks.
The benefits of mutual funds
The main benefit of mutual funds is that they offer investors diversification at a relatively low cost. When you invest in a mutual fund, you can get exposure to a wide variety of securities without having to purchase each one individually. It can help to reduce your overall investment risk; learn this here.
Another benefit of mutual funds is that they provide liquidity, which is the ability to quickly convert your investment into cash. For example, if you need to access your money for an emergency, you can generally sell your mutual fund shares and have the cash in hand within a few days. It is not the case with all investments, such as real estate or collectables, which can take much longer to sell.
Lastly, mutual funds allow investors to invest small sums of money. If you don’t have much money to invest, you can still get exposure to a diversified portfolio of securities by investing in a mutual fund. It is impossible with all investments, such as individual stocks, which generally have higher investment minimums.
What are the risks of mutual funds?
As with any investment, there are risks involved with investing in mutual funds. The most common risk is market risk, which is the possibility that the value of your investment will go down due to factors beyond your control, such as an economic recession or a stock market crash.
Another risk to consider is interest rate risk, which is the possibility that the value of your investment will go down if interest rates rise. It is more of a concern with bond funds, as they tend to be more sensitive to changes in interest rates.
Lastly, you should be aware of managing risk, which is the possibility that the fund manager will make poor investment decisions that result in losses. While all investors are subject to market risk, management risk is specific to mutual funds.
While there are risks associated with investing in mutual funds, they can be a helpful tool for investors looking to diversify their portfolios and access professional money management; learn this here.