People who have done it, Paul Navone and Warren Buffett themselves included, attest to the fact that becoming rich entails following three simple steps: SAVE, INVEST, REPEAT.
Well, yes, that has to be it since the majority of us were not born with a silver spoon, and would have to be ready to roll our sleeves up and work hard and smart if we’re serious about achieving the financial status we hope to achieve.
To save without much of the pain and on a sustainable basis, one needs to keep in mind the money equation that really works, with the purpose of building an emergency fund that would keep him and his family going in times of financial emergencies. This post assumes that the investor already has an emergency fund in place, at least three months worth of expenses.
With that said, let’s talk about mutual funds.
Investopedia.com defines a mutual fund as nothing more than a collection of stocks and/or bonds. Mutual funds bring together a group of investors and invest their money in bonds, stocks and other financial instruments.
Mutual funds are managed by a professional fund manager or broker, and they are beneficial to investors with little money, time and investing knowledge.
Before investing in mutual funds, though, remember to choose the best managed funds because there is no guaranteed return on investment.
Types of mutual funds
- Money Market Fund – This type of fund is made up of short-term debt instruments, mostly backed by the government. The returns are not that great, probably a little higher than the return one would get from a regular savings or checking account and slightly less than returns on a time deposit. It’s the best place to put one’s money, however, if one is risk-averse. Capital preservation is the name of the game.
- Bond Fund – Also known as fixed income fund, the primary objective of a bond fund is to provide a steady stream of cash to investors. Bond funds are mostly concentrated on government and corporate debt. The return on this type of fund is slightly higher than returns yielded by time deposits and money market funds.
- Balanced Fund – Balanced funds are named as such because they aim to provide capital preservation, appreciation and steady cash flow to investors. In a typical balanced fund, the strategy involves investing in fixed income investments and equities.
- Equities Fund – This fund is invested in stocks or equities. The purpose of this fund is to provide long-term capital growth. Of all the types of mutual funds, the equities fund carries the highest risk because of the volatility of the stock market, but historically speaking, it carries the most returns.
To know which fund to invest in, one must know his risk appetite.
Advantages of Mutual Funds
1. Diversification – One important investing rule is asset diversification or “not putting one’s eggs in a single basket.” When purchasing mutual funds, the investor is provided the instant benefit of diversification.
2. Economies of Scale – Now this term can be too financially “heavy” to explain in one go. But the best way to define economies of scale simplistically is thinking about discounts for bulk purchases. In purchasing stocks, if the investor purchases one stock at a time, the transaction fees slapped at him will be relatively huge.
Mutual funds, however, are able to take advantage of “bulk” buying and selling, thereby, reducing transaction costs for investors.
3. Money-Cost Averaging – This is the concept of investing equal monetary amounts periodically and regularly. In effect, more shares are purchased when share prices are lower, and less when they are higher.
To illustrate, say an investor initially invests 5,000 pesos in an equities fund at an average share price of 10 pesos each. If my math is correct, that should be a total of 500 shares. Next month, he can choose to top up his investment with another 1,000 pesos and add another 100 shares to his investment portfolio.
Assuming he does this on an ongoing basis, if share prices go down in January of next year, say at 5 pesos per share, he should be able to buy 200 more shares with his 1,000 pesos.
4. Liquidity – Mutual funds are generally liquid, meaning if an investor wishes to cash in on his investments at any given time, he is always free to do so.
5. Professional Management – Mutual funds are managed by professionals who carefully watch the financial market. They, therefore, relieve investors of the rigor of having to do the same.
In summary, after all is said and done, investors are cautioned to always bear in mind that as in any form of investing, mutual funds do not guarantee returns and can post risks. They are not immune to market fluctuations, and the returns they generate may not be at par with the overall market.
In addition, most mutual funds carry sales charges or commissions, annual fees and penalties for early withdrawal.
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