The understanding of mutual funds has the associations with the principals of certain kinds of securities. Despite these similarities, the basic principals are crucial as they help avoid making poor investment decisions. Mutual funds can help one obtain a good return as they offer a diverse opportunity in investment that reduces the chances of encountering the risks associated with investments. Mutual fund is a media that helps one invest in such a way that his/her money associates with other investments as money invested is used by management of the mother corporation to purchase other assets bounded by the investment principles (Tyson 10). This means that a certain organization obtains money from different people to invest to a certain project (Huang and Finch 45). Whenever one invests in to mutual funds, he/she is contributing to a huge investment scheme. The principals of investment determine the categories that diversely differentiate themselves. The terms associated with mutual funds are technical and therefore if one has to benefit from mutual fund investment, then, he/she should understand these terms well. From such difficulties, proper understanding of mutual fund principals is basic as it helps investors understand the industry well to make beneficial investments.
The Lending Investment
The doubts of understanding mutual funds should not compromise any investment decision. It is important to take time and set goals based on one’s financial necessities. Out in the market, there looks to ordinary person; there are thousands of investment opportunities. It is a complex situation but it all comes down to only two fundamental investment types, which include the lending and ownership investment types (Tyson 10). Lending investment is the kind of investment where by an investment scheme invests by lending their money to different individuals with a main goal of obtaining interest during the repayment of the principal loan given. Different organizations offer these loans and they include organizations such as banks that offer products like certificates of deposit, Treasury bills, and corporation bonds. In these circumstances, the investor is lending his/her money to an organization/corporations/bank by buying the products on offer with agreements that the investor gets back his/her money with interest paid at agreed rates. There is a set date when the principal is fully payable back. The lending investment scheme has assurance that there will not be compromising of set terms in receiving all earned interest together with the original investment amount. Such a deal might not bring the fortune as many may expect, but it is better comparing to the number of other investment plans that will end up paying nothing to their clients.
However, this investment option has its disadvantages. There is a possibility that one may fail to receive the promised amounts. This can happen when unfortunate circumstances like bankruptcy faces the scheme meaning either all investment goes down the drain of part of it. Secondly, since the repayable amounts are mature after a certain period, it might happen that by the time of getting back the money, inflation has taken effect such that the money will turn out to be worthless. One can find that the expectation of purchasing a certain item when he/she receives his check, the item is out of reach. For instance, in 1960s, Americans bought long-term bonds issued by various organizations at that time. The 4 % repayment interest looked a nice deal since the living standards at those times were low. Their expectation that the normal inflation rate of 2 % annually could not cause any alarm, but the inflation rose to 8 % rendering the 4 % repayment interest unsatisfying (Tyson 11). Finally, the other disadvantage of lending investment is that, the organization’s success to which one’s money is part, is not a share of the investor. If a company grows and succeeds because of investors’ contributions after purchasing the organization’s products like bonds, this success remains to the organization and its owners.
The Ownership Investment
The other kind of mutual fund is the ownership investment. This has a high potential to earn a great profit as well as risk. The term owner means that whenever one buys an asset, such as real estate or stock, he/she becomes the owner of that part of the corporation. This approach can produce profits by two methods. First, this can happen by the investment’s own cash flow where any profits from the corporation benefit the investors. For instance, dividends are benefits from a company’s profits. The other method is by appreciation in the value of the investment made. This can happen when one makes investment with a developing corporation, and then the appreciating value of the assets means profit to the investor. For instance, if ones sell his share in a company, the profit obtained is the investor’s own profit (Tyson 12).
Apart from the advantages of the ownership investment, it has its disadvantages as the endeavor can come with accountability. Being the owner of a certain assets means one has the responsibility for example, the owner is responsible for insurance cover of his property if it is a building against the possible risks like fire. A tenant will be enjoying his time as the owner tries to fix broken sewage. On another note, anything that has the advantage of appreciation has the risk of depreciation. The investment can reduce in value whenever prices in for instance stock markets crash or a company goes bankrupt (Tyson 12). This calls for proper management.
Fund managers manage collected funds from investors and determine the best investment options. Investment of this money should be in such a way that the return is the expected and impresses shareholders. For any business to succeed the quality of management is fundamental. Professional management will include the services provided by investment advisors (Haslem 58). Professional management can result from varied sources. First, it can result from inheritance where involvement of an individual in their successful family business ends up acquiring adequate investment knowledge. To some extend, non-owners end up managing the once owner-managed investment firms. The back here stops with exposure. Differently, education plays a major role in making of professional portfolio managers. They usually join investment companies from college from which they work their way up the corporate ladder. In fact, many investment companies use education to screen potential candidates. For example, The Fidelity Management in United States provides latest workstations for candidates who prove intelligent enough to build their professional careers (Haslem 61). Moreover, they continue their education to keep track of new and changing demands of the industry.
The industry cost, as researches indicate has been having stable expenses. A study by ICT’s and Reid in 1998 as reported in Huang and Finch showed that for a duration of 17 years since 1980, “mutual fund total costs declined by more than one-third, from 2.25 percent to 1.49 %. Overall, the reduced size and use of front-end loads more than compensated for increasing 12b-1 fees, which represent 37 percent of total distribution costs” (Huang and Finch 143). More so, the economics of scale show that the highest growth in asset shares usually depict the biggest reducing expense ratios. This indicates that stagnant expence ratios strengthen the dollar value in expenses as assets share increase while the asset increment remains not proportional to reductions.
To establish performance by managers of mutual funds, it is important to take note of the past records. The fact that history may fail to repeat itself, does not mean the history has no importance. Fund managers’ performance can be established using the past (Huang and Finch 62). In fact, the past better predicts failures compared to successes.
In summary, it is important to understand mutual funds principals as this helps one understand the industry proper to make fruitful investment. This is because there are many investments opportunities which can fail to perform. On its part, mutual fund investments have two kinds that include the lending and the ownership investment options. In lending investment, no company’s success is part of investors while for ownership investment; company’s success means profit to investors. Finally, the history is importance as prediction can tell the expected performance of fund managers. Proper understanding of mutual fund principals is critical as poor information can lead to poor investment.