Mutual funds 101: an introduction to investment funds
Investment funds, or mutual funds, are a popular way of gaining exposure to the financial markets. Mutual funds combine money from many investors and spread it among different investments. They provide investors access to professionally-managed portfolios that offer diversification across asset classes.
For many investors, investing in mutual funds is an attractive option because they can benefit from the expertise of experienced fund managers while sharing in the gains or losses of their underlying investments.
Furthermore, mutual funds offer liquidity and flexibility – investors can enter or exit the fund at any time without penalty, and the cost of trading shares within a fund is usually meagre compared to other investment options.
What investors need to know
Before investing in mutual funds, investors should know the risks and rewards associated with such investments. They should also understand the different types of mutual funds available and their fees and regulations. Acknowledging these factors will ensure investors make informed and appropriate decisions when investing in mutual funds.
Mutual fund risks
Investing in mutual funds carries several risks that investors should be aware of. The most common is market risk, where the value of investments can decrease due to changes in economic and political developments. You can view a reliable broker with updates on the economy and market analysis, such as Saxo Dubai Markets, to see these changes.
Additionally, there is credit risk, which involves the possibility that a company or other debt issuer will not pay interest or principal on its bonds as promised. Interest rate risk is also present, where changes in interest rates could negatively affect the values of debt securities held by the fund.
Lastly, there is a risk of liquidity, which means that if many investors decide to sell their shares simultaneously, it could result in the need to sell at lower prices than the original purchase price.
Types of mutual funds
- Mutual funds come in various categories, depending on the underlying investments.
- Equity funds invest primarily in stocks and aim to provide capital growth over the long term.
- Bond funds focus on fixed-income securities such as government bonds and corporate debt, aiming for steady returns with low volatility.
- Money market funds invest in short-term debt instruments such as treasury bills; they are considered relatively safe investments but usually offer lower returns than other mutual funds.
- Balanced or hybrid funds combine stocks and bonds to balance risk and return.
- Some speciality funds specialise in a particular sector, asset class, geographic region or investment style.
Fees and expenses
Investors should know the applicable fees and expenses when investing in a mutual fund. These include management fees, custodial fees, administrative costs, and transaction charges.
- Management fees are usually charged as a percentage of assets under management.
- Custodian and administrative charges cover services such as record-keeping and trust accounts.
- Transaction costs can also apply when buying or selling shares in a fund, although most funds offer low to zero commissions on transactions within the fund.
Furthermore, investors should be aware of the fund’s sales charges, which can affect their earnings if they decide to exit the fund.
Regulations and governance
Investors should understand the regulatory environment that governs mutual funds in their region. For example, all licensed public funds in the UAE must adhere to the Regulations of Financial Investments issued by the Emirates Securities and Commodities Authority (ESCA). It includes filing an annual report and an Investment Fund Guide outlining the fund’s objectives, fees, risks and management information.
Mutual funds must also have a board of directors for oversight on behalf of investors. They should be independent of the fund manager and have expertise in finance, law, accounting and other related fields. Lastly, public funds are required to appoint an auditor to ensure compliance with ESCA regulations.
Taxes can significantly impact returns from mutual funds investments, so investors should understand their appropriate tax treatment before investing. In the UAE, capital gains made through mutual fund investments are generally taxed at the prevailing personal income tax rate for resident or non-resident individuals, depending on their status.
Dividend income from mutual funds is generally exempted from taxation for resident taxpayers but subject to withholding tax for non-residents. Investors should also be aware that some funds may be subject to special taxes such as estate or gift taxes.