“I read in the financial papers that mutual funds are a good option for people who are looking for higher returns than available on regular savings account. What exactly are mutual funds and how do they work?”
The investment landscape in Jamaica is certainly undergoing some interesting changes. Gone are the days when people only saved in bank accounts- now they’re searching for more options that can give better returns on their investments.
What is a Mutual Fund?
A mutual fund is one of the investment choices that can offer an investor the opportunity to make more money. A mutual fund is simply a collection of assets such as stocks, money market instruments or bonds that are purchased by a pool of investors and managed by a professional company.
The mutual fund company has specific objectives as to how they can invest the money they have collected from investors. These details would be found in the prospectus of the mutual fund.
This type of pooled investment has actually been around for many years in Jamaica, although they have been traditionally known as unit trusts. There are some legal and structural differences between unit trusts and mutual funds, but they essentially do the same thing- purchase investments and manage them in order to make money for the investors.
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How is a Mutual Fund Valued?
When you invest in a mutual fund, what you are actually doing is purchasing shares or units in the fund. The number of shares you can get for your money is dependent on the individual price of each share. The share price, called the Net Asset Value or NAV, is calculated periodically, usually daily.
It is obtained by working out the value of all the assets that are held by the mutual fund, then subtracting any expenses incurred in the running of the fund, and dividing by the total number of outstanding shares available in the mutual fund.
A simple example of how this works is: if you had J$10,000 to invest in a mutual fund that had a share price or NAV of J$5, you would get 2,000 shares in the fund.
How Do You Make Money?
The primary way to make money with mutual funds is when the value of the share price increases over what you initially paid for it. So if your J$10,000 had bought 2,000 shares into the fund when the price was J$5, and now the NAV is J$10, your units would be worth J$20,000.
Some mutual funds also offer payments, called distributions, to investors based on the interest payments or stock dividends that have been received, or from the gains made while buying and selling the assets in the fund. However, for most funds in Jamaica today, you would have to sell the shares to actually reap your profits.
What are the Advantages and Disadvantages?
Mutual funds can allow smaller investors to take advantage of a larger pool of participants to invest in some securities that may have been out of their reach otherwise. For example, it might be difficult to buy several stocks with just J$10,000, but an equity fund will allow you to buy into a pool of stocks at a lower cost. Also, each investor regardless of size gets the same return.
Another benefit is that investors can rely on the expertise of the fund managers to make informed investment choices for them. With the different types of mutual funds that are available, you can find one that matches your investment objectives and suits your financial goals.
On the other hand, there are some negatives to investing in these funds. They do not give any guaranteed returns, and you could lose all or a portion of your initial investment. Most funds come with sales charges, some of which are applied when you buy into the fund, and some when you wish to sell your shares.
These fees vary and can adversely affect the overall outcome of your investment. You have to be careful as well about the mutual fund company’s track record of performance over the years.
Despite the possible drawbacks, mutual funds can provide you with higher returns on your money. It’s advisable to speak to a financial expert to find out which fund might best suit your investment needs.
Copyright © 2007 Cherryl Hanson Simpson. No reproduction without written consent.
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Originally published in The Daily Observer, February 08, 2007
Cherryl is a financial columnist, consultant and coach. See more of her work at www.financiallyfreenetwork.com and www.financiallysmartonline.com. Contact Cherryl