We don't all have the knowledge or time to build and manage a portfolio of investments. Mutual funds are a great alternative that can be used.
A mutual fund is a way for people to pool their money and invest it according to a goal that has already been set.
Each investor in the mutual fund gets a share of the pool based on how much he or she put in at the beginning. The mutual fund's capital is split into shares or units, and each investor gets a number of units equal to the amount they put in.
The goal of the mutual fund's investments is always decided ahead of time. Mutual funds invest in bonds, stocks, money-market instruments, real estate, commodities, or other investments, or often a mix of these.
The fund's prospectus has information about the fund's policies, goals, costs, services, etc. Every investor should read the prospectus before putting money into a mutual fund.
A fund manager decides how the pooled money should be invested (or managers). The manager of the fund decides what securities to buy and how many of them to buy.
The value of a unit of a mutual fund changes with the value of all of the investments made by the fund as a whole.
The NAV is the value of each share or unit of a mutual fund (Net Asset Value).
Different funds have different risk reward profile. When it comes to risk, a mutual fund that invests in stocks is riskier than one that invests in government bonds. Investors can lose money when the value of their stocks goes down, but their money is safe when it's in bonds (unless the Government defaults which is rare.) At the same time, the higher risk of stocks also means that you can make more money from them. Stocks can go as high as they want, but the most you can get out of a government bond is the interest rate the government gives you.
Mutual funds have been around since:
In 1774, people put their money together for the first time to invest. After the financial crisis of 1772–1773, a Dutch merchant named Adriaan van Ketwich asked investors to form an investment trust with him. The goal of the trust was to lower the risks of investing by giving small investors more ways to put their money to work. The money was put into investments in places like Austria, Denmark, and Spain. Most of the investments were in bonds, and only a small amount was in stocks. The name of the trust, "Eendragt Maakt Magt," means "Unity Makes Strength."
There were many things about the fund that attracted investors:
It has a lottery built into it.
There was a guaranteed dividend of 4%, which was just a little less than the average rate at the time. So, the interest income was more than what was needed to be paid out, and the difference was turned into a cash reserve.
- The cash reserve was used to buy back a few shares each year at a 10% premium, so the remaining shares earned more interest. So, the cash reserve kept growing over time, which made it faster for people to sell their shares.
At the end of 25 years, the trust would end and the money would be split among the remaining investors.
But because of the war with England, many bonds were not paid back. Due to a drop in investment income, shares could no longer be redeemed in 1782, and interest payments were also cut. Investors were no longer interested in the fund, so it went away.
After developing for a few years in Europe, the idea of mutual funds came to the United States at the end of the 1800s. The first closed-end fund was set up in 1893. The Boston Personal Property Trust was its name.
The first step toward open-end funds was the Alexander Fund in Philadelphia. It began in 1907, and every six months, a new issue came out. Investors could get their money back.
The Massachusetts Investors' Trust of Boston was the first real open-end fund. It was started in 1924, and in 1928 it went public. In 1928, The Wellington Fund was the first balanced fund to invest in both stocks and bonds.
In 1971, William Fouse and John McQuown of the Wells Fargo Bank came up with the idea of index-based funds. John Bogle made the first retail Index Fund in 1976, based on their idea. The name of the company was the First Index Investment Trust. The Vanguard 500 Index Fund is what it is now called. It had more than $100 billion in assets in November 2000, making it the largest fund in the world.
Mutual funds have come a long way over the years. About half of all US households put money into mutual funds. Mutual funds are also becoming more and more popular in places like India that are still growing. They have become the preferred way for many investors to put their money to work because they offer a unique mix of diversification, low costs, and ease of use.
