Understanding Mutual Funds as an Investment Option in 2021

Richmond Kwame Frimpong

Financial Wellness with Richmond Kwame Frimpong

Put simply, a mutual fund is a pool of funds(money) collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. It usually employs a professional fund manager to manage the investment. The manager’s goal depends on the type of fund: a fixed-income fund manager, for example, would strive to provide the highest yield at the lowest risk. A long-term growth manager, on the other hand, should attempt to beat the GSE All-Share Index or the S&P 500 in a fiscal year.

A mutual fund may either be open-end or closed-end.

Open-end Mutual Funds

Open-end funds stand ready to issue new shares or redeem outstanding shares on a continuous basis. This means that the fund does not have a set number of shares. Instead, the fund will issue new shares to an investor based upon the current net asset value and redeem the shares when the investor decides to sell. In sum, you can buy (invest or top-up) at any time.

Closed-end Mutual funds

These are funds that issue a fixed number of shares and do not stand ready to repurchase their shares from their shareholders when they decide to sell them. The Securities Industry (Amendment) Law requires that closed-ended funds be listed on an organised exchange in order to provide liquidity to the shareholders. These shares are traded at prices determined by the laws of supply and demand. In sum, you cannot buy (invest or top-up) after the Initial Public Offer (IPO) period.

What are the benefits of investing in a mutual fund?

  1. a) The Investor gets the services of a Professional Fund Manager: Mutual funds are actively managed by a professional Fund manager who constantly monitors the stocks, bonds etc. in the fund’s portfolio. Because this is his or her primary occupation, they can devote considerably more time to selecting investments than an individual investor. This provides the peace of mind that comes with informed investing without the stress of analysing financial statements or calculating financial ratios.
  2. b) The Investor gets the benefits of Diversification: Diversification is simply not “putting all your eggs in one basket”. Mutual Funds invest in a number of different securities, and that helps reduce the risk of investing. When the investor buys a share/unit in a fund, he/she buys an interest in a portfolio of dozens of different securities – giving him/her instant diversification, at least within the type of securities held by the fund. For example, a portfolio made up of shares from various companies, fixed-term, and money market securities is a good example of diversification.
  3. c) The Investor gets liquidity and flexibility: Shares of open-end mutual funds can be redeemed at any time at the Net Asset Value Per Share (NAVPS) of the fund. Many fund management companies administer several different funds (e.g. money market, fixed-income, growth, balanced and international funds) and allow the investor to switch between funds within their ‘fund family’ at little or no charge. This can enable the investor to change the balance of his portfolio as his personal needs or market conditions change.
  4. d) The Investor gets Tax Advantages: Under current tax laws, Collective Investment Schemes do not pay taxes on their incomes. Again, investors in these schemes do not pay taxes on incomes received from these schemes. These tax incentives have been designed to encourage the pooling of investors’ resources together for investments to develop the economy

Caution on Investing in Mutual Funds

  1. a) Past performance does not guarantee future performance. In other words, last year’s ‘number-one’ fund can easily become the next year’s below-average fund. So, an investors’ decision to invest in a particular mutual fund should not only be based on the Funds’ past returns’ record. Inversely, past performance can help an investor assess a fund’s volatility (risk/return profile) over time.
  2. b) All things being equal, the more volatile a fund, the higher the investment risk. So, if you need your money to meet a financial goal in the near-term (say 91 or 182 days), you probably cannot afford the risk of investing in a mutual fund with a volatile history, because you will not have enough time to ride out any declines in the stock market.
  3. c) Mutual funds and their returns are not guaranteed or insured. An investor can possibly lose money investing in mutual funds over a period and vice versa.
  4. d) The combined holdings the mutual fund owns are known as its portfolio and each share (unit) represents an investor’s proportionate ownership of the fund’s holdings and the income those holdings generate.
  5. e) Mutual fund shares are ‘redeemable’ – meaning investors can sell their shares back to the fund (or to a broker acting for the fund).
  6. f) Mutual fund shares are purchased from the fund itself instead of from other investors on a secondary market, such as the Ghana Stock Exchange (in Ghana) or the New York Stock Exchange (in the United States of America).
  7. g) The price that investors pay for mutual fund shares is the funds per share net asset value (NAV) plus any shareholder fees that the fund imposes at the time of purchase (such as exit loads).

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