Mutual Funds

Mutual Funds:

Mutual funds are pooled investment vehicles that are either actively managed by professional fund managers or passively track an index or industry. Mutual funds can invest in stocks, bonds, money market instruments and other securities. In a typical mutual fund, the manager trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The gains are then passed on to investors in the form of dividends and capital gains. A typical way to track the performance of a mutual funds is by calculating the Net Asset Value per share (NAV), which is calculated by the total value of the fund divided by the number of shares outstanding. NAV is typically calculated every day at the close of a specified financial exchange.

Rationale

Top 5 Mutual Funds

A look at the top five mutual funds currently in the market

The strength of a mutual fund lies in its ability to diversify risk. Instead of piling money into a small number of companies, a mutual fund spreads its money over most companies in, for instance, the oil industry. If one company turns out to have kleptocratic management, or lose significant value in a similarly unpredictable fashion, the overall impact on the fund is marginal. It effectively minimizes the unsystematic risk of an investment, by diversifying the portfolio across different companies, sectors, nations, and/or whatever other factors the fund manager chooses to specialize in.

Mutual funds have become enormously popular as a savings vehicle in the United States. Individuals do not have the time to research individual companies on par with banking analysts; do not want to pay the prohibitive transaction costs which individual investing entails; and do not want to be exposed to the ups and downs of individual company risk. Mutual funds offer an attractive way for savings to be managed in a fairly passive manner, without requiring very high fees or attention from the individual investor. (A large body of academic research, bankers' experience, and data show that the average investor is crushed over time by high fees and poor information, and that passive approaches to fund management offer superior returns for the overwhelming majority of investors.)

Mutual funds have come under fire in recent years for allegedly charging exorbitant fees. A new breed of mutual fund, the "exchange-traded fund" (ETF), takes the ideas of minimal fees and passive management to a new level. ETFs usually track a large index such as the S&P 500, are passively managed, and charge extremely low fees.