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The Risk and Rewards of Investing in Mutual Funds The Risk and Rewards of Investing in Mutual Funds

If you are worried about keeping an eye on the money you invest in shares, then it is best to invest in mutual funds. Mutual funds are a combination of shares and bonds chosen to provide optimal benefits for its fund holders.

As mutual funds are managed by the experts to provide good returns with minimum risks, they are much less stressful than investing in individual shares. In this blog, we will see the basics of investing in mutual funds and compare the pros and cons that come with it.

 

How Are the Mutual Funds Managed?

Mutual funds are managed by its fund managers who are experts at analyzing the stock market and bonds to devise the fund for high returns. Mutual fund managers take into consideration a variety of elements when deciding the funds.

  • Active and Passive Funds

    Actively managed mutual funds are designed with a group of companies that are believed to outperform the overall market. The mutual fund managers analyze the company fundamentals, its past records and uncover patterns that are not evident and create a fund that brings in a profit.

    On the other hand, passively managed mutual funds are designed towards a long-term return strategy by investing in a market index fund.
    The fund managers who manage the passive mutual funds are of the opinion that the future of the company’s shares cannot be predicted by the current data and that simply investing in the entire market will fetch good returns in the future.

  • Growth and Value Stocks

    This is again a common term you will come across if you are searching to invest money in mutual funds.
    The growth-based mutual funds are designed to bring in high returns as the investors pay a high premium. Therefore, these mutual funds consist of high-risk stocks that are unpredictable and prone to be volatile.

    Value-based stocks have the undervalued stocks that do not seem to have much potential in the present but may yield high dividends in the future.

    These are low-risk mutual funds that don’t affect the fundholder much even in times when the market rates are low.

How Much Can You Invest in Mutual Funds?

The rule of investment applies to all, no matter what the kind of investment you are seeking out – do not invest more than you can afford to lose. Though mutual funds are less risky than investing directly in the share market, you cannot take a considerable risk that is beyond your capability to manage. When you are just starting in the mutual fund market, it is advisable to start slow, compare the different funds, experiment with some before investing a large amount of money.

Though you may see a huge potential in some funds, do not put all your investment in the same mutual fund or, for that matter, only in the mutual fund. Spread out your investment among other modes too to brace yourself if the market hits down very hard.

Generally, it is considered safe to go with 5% of the amount you are planning to invest in the beginning. Study the movement of the market for a few months, the management of the mutual funds and the changes in the industry you have invested in. Once you are sure about the fund, you can incrementally increase your investment.

What Are the Different Kinds of Mutual Funds to Invest in the UK?

There are many kinds of mutual funds, among which you can choose based on your individual needs. Let’s have a glimpse into the common ways to invest in UK stocks through mutual funds.

  • Property Funds

    Among the property funds, there are various types, all of which are related to build or secure a property.
    Some property funds help the companies to manage a shortage of cash flow while some other funds take charge of finding tenants and maintaining buildings and a share of the rents from these buildings will go towards the return. If you are planning to invest in the property funds, make sure to have a good idea of the types and how the returns are decided.

  • Unit Trusts and Offshore Funds

    These funds are relative based on the number of investors who are currently involved.
    If more investors want to get a piece of this fund, the share amount divides and similarly, if many numbers of investors sell, this decreases.

  • Exchange-Traded Funds (ETF)

    Exchange-traded funds are like any other mutual funds that are matched with a specific commodity or a specific market index. The main difference in the ETFs is that they can be bought and sold on the share market like any other share.

How Should You Choose the Mutual Funds to Invest In?

  • Your Goals

    Everyone has different goals for investing in mutual funds. Some may look for long-term investments while some may invest for a purpose; like college funds, buying a car, or a house. Therefore, first have a clear vision of why you want to invest, the number of returns you are expecting and the duration you wish to continue with the investment.

  • Risk Tolerance

    Mutual funds are not without the risks and you may witness swings in your holdings towards the side of loss. Knowing how much damages you can withstand is vital for any investment. Even before you invest money, decide how much money you can afford to lose and the limit after which you need to pull out.

  • The Kind of Appreciation

    If you are planning for high returns after a good period without any expectation of dividends in between, then the growth funds are best suited for you. In case you need the interest paid out in the form of dividends, then it is best to choose the value-based mutual funds. Similarly, based on your research on the stock market, you can choose between passively and actively held mutual funds.

  • The Fees

    As the fund manager is managing the funds for you, you will be charged a percentage of your investment as fees. It can be in the form of front-end load fees or back-end load fees. In the front-end load fees, a percentage of your investment is paid out at the time you buy the shares. The back-end load fees are paid out to the fund manager at the time you sell the shares. There is also a level-load fee, which is an annual fee for maintaining the funds.

    If you invest in the UK stock market through mutual funds, the load fees can typically be anywhere between 3% to 6% based on the stocks and the institution managing the mutual funds. When you are investing in mutual funds, make sure to factor in the fees and find out the number of returns you will get.

  • Fund Managers

    Fund managers are vital to any mutual fund as they can make or break the profits. Make sure to get the past results of the fund managers, analyze the industries they work the best, how they invest stocks and the ability of the fund manager to handle the said mutual fund till then. Here are a few points to note from the fund manager’s past funds.

  • The volatile level of the funds
  • The fund turnover 
  • The industries the manager has handled
  • The years of experience and the duration for which the funds are run
  • The vital changes the manager has made in the past funds concerning the market scenario

What Are the Risks of Investing in Mutual Funds?

  • Based on the market risk, the value of shares you hold may go up or come crashing down.
  • You may not be able to top the inflation even with some profit from the mutual funds.
  • If you are dealing with foreign-based mutual funds, the exchange rate of the currency can have a grave effect when you get returns back. 
  • Some mutual fund holders may leave you open for credit risk; meaning they may not have the money to make the interest payments to you.
  • Mutual funds are generally for medium to long term investments and therefore, you may not get a good return when compared to the inflation rate when you pull out in the middle.

This kind of risks with mutual funds can be avoided if you do complete research before you invest money. Be aware of all the subject risks and ensure that you have protection in case any of these risks become real.

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