What is a Mutual Fund?
A Mutual fund is a professionally managed investment portfolio that allows investors to pool their money together to invest in some selected asset classes to make a profit at a minimum risk level. These asset classes include company shares, bonds, money market instruments, real estate and so on.
Mutual funds are operated by professional fund managers and are regulated by the Securities and Exchange Commission (SEC) in Nigeria. SEC monitors, receive periodic report of the fund and provides guidelines as to the management of any mutual funds.
The concept of mutual funds allows small investors to take part in major investments which they might not have access to because of the high minimum investment requirements. With mutual funds, several investors can pull funds together and invest to earn benefits based on the ratio of their investments.
A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus. Mutual funds can be used for any type of investment for example if you want to buy a property for rental income and it costs N100Million which you do not have.
With a mutual fund, you can have 10 investors coming together to raise N10million each, buy the property and each would get 10% of the rental income.
Types of Mutual Funds
1. Money Market Funds
These funds invest in short-term financial instruments such as Treasury Bills and Commercial Papers among others. By short-term, it means less than a year, your money is lent to institutions like the Central Bank and trusted private companies for short term needs at a particular rate. These instruments are very liquid short-term investments with high credit quality.
2. Bond Funds
Bond funds are also known as Fixed Income Funds, they invest solely in bonds. A bond is a long-term loan agreement between a lender and a borrower (trusted party) such as government and corporate organization.
3. Special Funds
As the name implies, these funds have a unique focus. A specialized fund is a fund that does not just have its focus on traditional investments (Equities, Bonds and any other fixed-income instrument) but with a specific focus on the value-driving it. For instance, a special fund might choose to invest only in dividend-paying stocks or Banking Stocks or in developmental projects. In summary, they are mutual funds that pick specific interests to invest in.
4. Equity Funds
The term equities refer to shares or stocks. With equity funds, your money is invested in shares traded on the floor of a stock exchange. This fund is usually for individuals that love to take high risk with the expectation of high returns.
There are several other types of Mutual funds, so it is important to read about the funds and what it invests in. Some fund invests in a combination of assets by allocating various percentages of the fund to the various asset classes.
For example, you could have a fund that states that 50% of the funds would be invested in the stock market, 25% investment in Fixed income and the balance in property.
You should also note that your investment is in the fund and not on the asset. You cannot lay claim to the assets the fund has invested in but you are entitled to the returns generated from the asset based on the amount you invested.
How to Purchase Mutual Funds
Mutual funds are open to any legal entity individuals, corporates, associations etc. There are two main approaches. You can buy the mutual fund from an exchange or directly from the fund manager.
If you are buying from an exchange (which means it is an exchange-traded fund) you need to have an account with a stockbroker. Opening an account requires your passport photograph, means of identification(Driver’s License, International Passport, National ID or Voters Card) and a utility bill of not more than 3 months which should clearly show your address (the process of Know Your Customer)
Some brokers will require an amount to open the account but such monies are credited to you for purchase. Ensure that you have a valid bank account and your BVN.
If you are under 18years, an adult is required before your account can be opened. These are regulatory requirements for Know Your Customer (KYC). Once your account is opened you can instruct your broker to purchase the fund from the floor of the exchange.
You can also approach the Fund Manager of the mutual fund and buy directly (purchase across the counter). The same requirements for opening an account applies before purchase.
The price of the fund depends on the fund and how well it is performing or growing. For existing funds, there is an offer price and bid price. When you see the listing of a fund is it usually displayed in this format XYZ Mutual Fund Offer Price: 20K Bid Price 30K. The bid price is the price at which you can buy the fund and the offer price is the price for which you can sell the fund if you already own it.
These prices change daily depending on how well the fund is doing. The price is quoted in units i.e., one unit of the fund could cost N1. However, most funds require you to purchase a minimum of say 5,000 units initially and you can then add additional units of 1,000. By implication, it would cost you N5,000 and additional purchase would cost N1,000. There are no additional charges.
Making Money with Mutual Funds
The fundamental reason for a mutual fund is that it gives you access to investments with high returns with minimal investment. Take the example of buying a N100millon property, if you have to wait to get N100million before you start the investment it would take a long time but with the mutual fund, you start benefiting from the rental income immediately at the percentage that you can afford.
The fund, once it starts appreciating, the value increases. You could buy a mutual fund at N1 per unit and the value increases to N1.50, if you sell, you have made a profit of 0.50K on each unit. The fund also pays dividend. At an agreed period, you get a share of the income made by the fund to the ratio of your holding.
Investing in Mutual Funds vs. Investing Directly
1. Lower Risks: A fund is made up of various assets mostly and not just one stock. That way, if some asset underperforms the others can cover for them. On the other hand, if you hold on to one asset and it underperforms you get to experience a massive loss.
2. Lower Entry: You can invest at lower minimum values than actually buying into the asset directly
3. Less Stress: Can you imagine yourself sitting to read through the financial statements of various investments you have? Mutual Funds are managed by professional who ensures that the investments are professionally managed and make decisions to prevent loss of fund.
4. Professionally managed portfolio: Mutual funds are professionally being managed by licensed Fund Managers and supervised by the Securities and Exchange Commission.
5. Mutual Funds are safe: There are other parties to the management of a mutual fund. This includes Fund Custodian who sees to the safe keep of the fund assets; Trustee who holds the investment for the benefit and interest of the unit holders/investors and several other parties
Frequently Asked Questions
Are Mutual Funds safe?
Mutual funds are safe to invest in. They are usually being managed by Professionals who have adequate knowledge about the fund. However, there are circumstances that may be beyond the control of the Fund Managers. These circumstances may be natural occurrences, political unrest, changes in certain economic conditions among others.
Are Mutual Funds Taxable?
Generally, yes, taxes must be paid on mutual fund earnings, also referred to as gains.
Are Mutual Funds Liquid?
Mutual funds are considered as liquid investments because investors can decide to sell their shares at any time and get their money when they need them.
Are Mutual Funds Halal?
Not all mutual Funds are Halal. Halal Funds are Muslim ethical Funds. However, any investor who is interested can invest in it. Therefore, not all mutual funds are Halal Funds.
Can Mutual Funds be Transferred?
Mutual funds units cannot be transferred from one person to another or given as a gift to a third party. Third-party payment is allowed in Mutual fund.
Can Mutual Funds be withdrawn anytime?
Mutual funds can be withdrawn anytime because it’s a liquid investment and also an open-ended fund.
Do Mutual Funds Pay Dividend?
Its required by law that dividends from mutual investments be passed on to their investors. A mutual fund investor may decide to take dividend distributions when they are being issued or may decide to reinvest the money.
Do Mutual Funds have Compound Interest?
It provides one of the simplest means for investors to make the most of Compound interest, in the sense that the more money an investor invests in the fund, and the longer the money stays, the more compound interest the investors get.
Do Mutual Funds pay Capital Gains?
Taxes are been charged based on the capital gain
Do Mutual Funds have Lock-in-Period?
It depends on if the fund is an open or closed ended mutual fund investments. All closed ended mutual funds have a lock-in-period, while open ended mutual funds do not have a lock-in-period. However, for an open-ended mutual fund, investor is charged what is termed as an exit load if the investor exits within a year.
Are Mutual Funds Regulated?
They must comply with some set of rules and regulations, which are being monitored by SEC.
Are Mutual Funds Actively Managed?
They are actively managed, unlike ETFs, that are passively managed
Should I Buy Mutual Funds or ETFs?
Choosing which of the two funds to buy is not a straightforward answer, nevertheless, there are some factors to consider before deciding between the two, which includes
- Mutual funds are actively managed by a professional, unlike ETFs, that involves passively tracking an index.
- ETFs are more tax efficient and more liquid than Mutual funds.
- ETFs are generally cheaper than mutual funds
- ETFs can be bought through almost any online broker, while Mutual funds are not always available through brokers