How Do Mutual Funds Work

How Funds are sold

Mutual Funds primarily depend upon individual agents and distribution companies to market their schemes to the investors. Nowadays, they also market their schemes directly.

The individual agents who sell schemes of various Mutual Funds also act as financial advisors to many investors. Hence they are required to clear various examinations before acting as an agent. Many Mutual Funds prefer to deal with distribution agency than individual agents as it is easier to manage. These distribution agencies, with their highly qualified executives, will be able to offer better financial advice than individual agents to the investors.

Nowadays, the sales officers and other employees of the investment companies directly approach the investors (particularly the high net worth individuals and corporate clients) to sell different schemes. However, most of the sales of Mutual Funds happen through other distribution route than from marketing directly.

Investment Policies
Every Mutual Fund has a specified investment policy which will be described in the Mutual Fund's prospectus. A family of Mutual Funds will be managed by an Asset Management Company. This Asset Management Company will collect funds from investors and charge a management fee for operating them. They enable investors to invest across different market sectors and switch assets across funds while still benefiting from centralized record keeping.

The investment policies of different types of funds are as follows:

• Equity Funds. They invest in stock. However, they will hold 4% to 5% of their assets in money market securities to offer liquidity. Income funds will hold shares of firms giving high dividend yield and Growth funds will hold shares of firms that enable faster capital appreciation. Sector funds focus on a particular industry.

• Debt Funds. These funds invest in fixed-income securities. Different funds will concentrate on Treasury bills, corporate bonds, Mortgage-backed securities and other kinds of bonds. Some of the funds also specialize on maturity.

• Index Funds. Index funds buy shares that are included in a particular index in proportion to each share's representation in that index. Investing in index funds is a passive strategy because the investors need not do any security analysis.

• Money Market Funds. These funds invest in short-term low-risk instruments of the money market. Since the liquidity is high, some of the funds even offer cheque writing facilities to their investors.

Why Should I Invest in Mutual Funds Instead of Stocks?

Investing in the stock market can be both very lucrative and risky. If you know what you're doing, or you are very lucky, you can make a lot of money. The historical average return is about 13% which is higher than a lot of other available investments such as bonds. Then there are mutual funds. A mutual fund is basically a collection of stocks and/or bonds. If a mutual fund is made up of stocks, why not just buy stocks?

First of all, not all mutual funds are made up entirely of stocks. Some funds include bonds, real estate, currency, commodities, and other investments. That alone is one great reason to invest in mutual funds instead of stocks; you get instant diversification. If you want to invest $1,000, there are only so many different companies' stock you can buy. With mutual funds, your money is pooled with other people's money so that you are able to get a small bit of hundreds of investments that will greatly reduce the risk of your investments.

That brings us to our next point, affordability. The average person probably can't afford the $20,000 up front investment needed to have a well diversified portfolio. With a mutual fund, you don't have to worry about diversification because it's already done by the fund manager for you. Also, investing in stocks can have a lot of costly fees. If you opt for no-load mutual funds, you don't have to pay any fees. You don't have to worry about trading fees that can be very steep when buying and selling stocks.

Finally, mutual funds are easy investments. If you want to invest in stocks you have to research stocks by reading financial statements, reviewing history, and understanding what you are doing. This takes a lot of time and effort that you can only get past if you pay a financial advisor or stock broker a pretty penny to do this for you. With mutual funds, you can invest in a no-load fund that has no fees and get professional stock picks. Now understand that nobody can successful predict the stock market 100% every time, but a financial professional can at least make possibly better picks than you.

If you've finally realized that you need to be investing your money, and you don't know how to invest or what to invest in, start with mutual funds. Watch your money grow, and if you ever feel confident enough you can buy your own stock picks. Until then, don't waste precious time, start investing right away!