Investing in Mutual Funds
· October 6th, 2006
You have finally managed to save some money for a rainy day. How can you make sure your money works as hard for you as you did for it? Investment choices are endless and can be quite daunting. One option available is to invest in a collective investment scheme, more commonly known as a mutual fund.
What is a mutual fund? In its purest form, a mutual fund is a vehicle which permits investors to pool their money and invest together in a portfolio or basket of investments chosen and managed by professional investment advisers. When you buy an interest in a mutual fund you are not only buying a piece of the investments made by that fund but you are also purchasing the services of top professional investment advisers. The services provided by these individuals and the buying power of pooled assets exceeds those available to most individual investors.
Investing in a mutual fund is a relatively straightforward process. Most mutual funds are set up as companies and sell their shares to the public at regular intervals, i.e. daily, monthly or quarterly. As a matter of law in most places including Bermuda, mutual funds must prepare what is called a prospectus or offering document. An offering document is meant to provide you with all the information you will need in order to decide if you want to purchase shares in a specific mutual fund. The laws of the place in which the mutual fund is created normally require the extensive information included in the offering document. For Bermuda incorporated funds, the Bermuda Monetary Authority has set clear guidelines on what information must be included in the offering document. The BMA is also responsible for approving the investment adviser, custodian and other service providers to the fund.
Once prepared, the offering document must be delivered to you in advance of your deciding to invest in the fund. It should be read very carefully as it outlines your rights as a shareholder of the fund, what fees will be charged to the fund by the investment advisers and others for their services to the fund (and indirectly to your investment), the type of investments the fund will make and what experience the service providers to the fund have. The risks that your investment will be exposed to are also required to be discussed and should be reviewed thoroughly. If you are in any doubt about the contents of an offering document or how it will affect your investment you should contact a qualified investment professional or attorney to ensure the fund meets your investment objectives.
Shares of a mutual fund can be offered in any number of currencies, including Bermuda dollars and may be subject to a minimum investment ranging anywhere from $50 to over a $1 million depending on the target investor for the fund. It is always a good idea to check with the fund’s administrator to see if a set minimum investment can be waived at the fund’s discretion.
In certain circumstances, mutual fund shares may also be subject to a load or fee when you purchase them. This is usually the case when you purchase mutual funds from independent financial brokers rather than from the mutual fund company itself. The fee will normally amount to a percentage of your investment (anywhere from 1% to 5%) and can be charged when you initially invest or at the time you take your investment out of the fund. Loads have traditionally also been used as a way of keeping investors invested in a fund as higher fees or loads are charged if you exit the fund early (i.e. in the first few years of investment) while decreased loads are charged the longer the investor stays in the fund. Many funds are no load and do not charge a fee for investing. This can be an important consideration in determining where to invest your money. A load should not be confused, however, with the fee charged by the investment advisor for its services to the fund itself. While you do not pay the investment advisor directly, it does take a fee out of the pooled assets of the fund as whole.
The amount you have to pay for an already established mutual fund’s shares will usually depend on the net asset value of the share or NAV. A share’s NAV is essentially the value of all of the fund’s assets on a given day minus its expenses (such as the fees paid to the investment advisor, operating expenses etc) divided by the number of shares the fund has issued. Unlike a traditional company, many mutual funds will allow you to purchase a fraction of a share in order to maximize your investment. Once invested, you make money in a fund when the NAV of your shares exceeds the amount you paid for them.
Once you decide in which fund you would like to invest, the next decision you will have to make is how you want to deal with any distributions’ the fund may make. Most funds make a payment to investors on a regular basis of a portion of the increase in the value of the portfolio of the mutual fund. This is very similar to a dividend payment in a traditional company. Some funds will not give you a choice as to how you will receive these distribution; others may allow you to choose to take these distribution either in cash or to reinvest them in more shares of the mutual fund. How you choose to take your distribution is entirely up to you and your investment goals.
So how long do you have to stay in a mutual fund in order to maximize your return on your investment? Most investment professionals advise keeping your investment in your selected mutual fund for at least three to five years. This enables you to weather any ups and downs in the market and obtain the best possible return on your investment. When you decide it is time to exit your mutual fund, regard will have to be paid to the mechanism to redeem or cash in your investment. Most funds will explain within the offering document the procedures and time frames involved for making redemptions of shares. Some funds allow daily redemptions; others may only allow weekly, monthly or quarterly redemptions. On occasion, as indicated earlier, fees can be charged by the fund when you redeem your shares. These are important considerations in deciding in which mutual fund you want to invest as essentially you will not be able to get access to your money other than on these prescribed redemption dates.
In today’s investment world there really is a mutual fund for everyone’s investment style and risk level from low risk funds that invests in safe securities such as government bonds to those that throw caution to the wind in the hopes of making big returns by investing in speculative securities. Regardless of where you choose to invest, educate yourself about the options available and ensure you familiarize yourself with the applicable offering documents. It’s your money and only you can protect it and make it grow.