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Each one of us does not have the
expertise or the time to build and manage an investment
portfolio. There is an excellent
alternative available – mutual funds.
A mutual fund is an investment
intermediary by which people can pool their money and
invest it according to a predetermined objective.
Each investor
of the mutual fund gets a share of the pool
proportionate to the initial investment that he makes.
The capital of the mutual fund is divided into shares
or units and investors get a number of units
proportionate to their investment.
The investment objective of the mutual fund is always
decided beforehand. Mutual funds invest
in bonds, stocks, money-market instruments, real
estate, commodities or other investments or many times
a combination of any of these.
The details regarding the funds’ policies,
objectives, charges, services etc are all available in
the fund’s prospectus and every investor should go
through the prospectus before investing in a mutual
fund.
The investment decisions for the pool capital are made
by a fund manager (or managers). The fund manager
decides what securities are to be bought and in what
quantity.
The value of units changes with change in aggregate
value of the investments made by the mutual fund.
The value of each share or unit of the mutual fund is
called NAV (Net Asset Value).
Different funds have different risk – reward
profile. A mutual fund that invests in stocks is a
greater risk investment than a mutual fund that
invests in government bonds. The value of stocks can
go down resulting in a loss for the investor, but
money invested in bonds is safe (unless the Government
defaults – which is rare.) At the same time the
greater risk in stocks also presents an opportunity
for higher returns. Stocks can go up to any limit, but
returns from government bonds are limited to the
interest rate offered by the government.
History of Mutual Funds:
The first “pooling of money” for investments was
done in 1774. After the 1772-1773 financial crisis, a
Dutch merchant Adriaan van Ketwich invited investors
to come together to form an investment trust. The goal
of the trust was to lower risks involved in investing
by providing diversification to the small investors.
The funds invested in various European countries such
as Austria, Denmark and Spain. The investments were
mainly in bonds and equity formed a small portion. The
trust was names Eendragt Maakt Magt, which meant
“Unity Creates Strength”.
The fund had many features that attracted investors:
- It had an embedded lottery.
- There was an assured 4% dividend, which was slightly
less than the average rates prevalent at that time.
Thus the interest income exceeded the required payouts
and the difference was converted to a cash reserve.
- The cash reserve was utilized to retire a few shares
annually at 10% premium and hence the remaining shares
earned a higher interest. Thus the cash reserve kept
increasing over time – further accelerating share
redemption.
- The trust was to be dissolved at the end of 25 years
and the capital was to be divided among the remaining
investors.
However a war with England led to many bonds
defaulting. Due to the decrease in investment income,
share redemption was suspended in 1782 and later the
interest payments were lowered too. The fund was no
longer attractive for investors and faded away.
After evolving in Europe for a few years, the idea of
mutual funds reached the US at the end if nineteenth
century. In the year 1893, the first closed-end fund
was formed. It was named the “The Boston Personal
Property Trust.”
The Alexander Fund in Philadelphia was the first step
towards open-end funds. It was established in 1907 and
had new issues every six months. Investors were
allowed to make redemptions.
The first true open-end fund was the Massachusetts
Investors’ Trust of Boston. Formed in the year 1924,
it went public in 1928. 1928 also saw the emergence of
first balanced fund – The Wellington Fund that
invested in both stocks and bonds.
The concept of Index based funds was given by William
Fouse and John McQuown of the Wells Fargo Bank in
1971. Based on their concept, John Bogle launched the
first retail Index Fund in 1976. It was called the
First Index Investment Trust. It is now known as the
Vanguard 500 Index Fund. It crossed 100 billion
dollars in assets in November 2000 and became the
World’s largest fund.
Today mutual funds have come a long way. Nearly one in
two households in the US invests in mutual funds. The
popularity of mutual funds is also soaring in
developing economies like India. They have become the
preferred investment route for many investors, who
value the unique combination of diversification, low
costs and simplicity provided by the funds.
By completeonlinetrading.com
Know more about mutual funds at http://www.completeonlinetrading.com
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