Fund Summary
How to make a lot amount of money investing in mutual funds by taking advantage of compounding returns?
What is mutual fund? A mutual fund is a group of portfolio of different stocks invested by a management team (for a small fee of course). Investors in mutual funds purchase a share valued at Net Asset Value (NAV) which can be considered as the price of a share of that mutual fund. A share of that mutual fund represents a percentage of ownership in a portfolio of stocks that diversified using a set of investment objectives outlined in that mutual fund’s prospectus.
Mutual funds are meant to be longer term investment alternatives, much like holding a piece of real estate. A mutual fund helps you, as an investor, take advantage of diversification at a cheaper cost of doing it yourself. Mutual funds can make you quite a bit of money over the long term because of compounding interest. Compounding interest is especially when the investor is reinvesting dividends and capital gains back into the investment portfolio. By the rule of compounding, it would take you, as an investor, 7.2 years to double your investment assuming that you are getting 10% return on your mutual fund investment (72 / divided by your expected return on mutual fund: 10%).
Diversification is used to lower risks specific to an individual stock and this done by an investor adding more uncorrelated, or unrelated, stocks into his or her portfolio. This decreases the investor’s exposure to the failure of any single stock investment in the portfolio. By theory, there are two types of risks surrounding stock investments. There is unsystematic risk which is specific to that stock investment (i.e. very costly litigation against a company). Conversely, there is systematic risk which is risk related to the stock markets in general (i.e. financial market collapse). Diversification serves to lower unsystematic risk and mutual funds are good alternative for a diversified portfolio at the price of NAV (Net Asset Value) per share.
Understanding your objectives as an investor should be the first step in determining which mutual fund is right for you. Three important factors that summarize your investment objectives are return expectations from your investment portfolio, level of risk, and time horizon. In the investment world, there is always a trade off with return and risk: the higher the risk, the greater the expected return. An investor’s level of risk tolerance are determined by factors such as the investor’s required spending needs, long-term wealth goal, and current level of debt. The time horizon element is crucial because it is the time period that the returns from the investment portfolio will be used (i.e. retirement, paying for college tuition, etc.).
For every investment objective, there is an appropriate mutual fund investment strategy. Some examples of the different mutual fund strategies include growth funds, value funds, balanced funds, bond funds, small cap funds, large cap funds, international funds. If an investor has a longer time horizon with a high level of risk tolerance, that investor may choose to look at growth funds to maximize portfolio performance over the longer holding period. Conversely, if an investor has a shorter time horizon with a low level of risk tolerance, that investor may choose to look at value funds or balanced funds for a shorter holding period.