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Investing 101: Mutual Funds

A mutual fund is a pool of money that is used to invest in anything from stocks and bonds to derivatives and precious metals. Mutual funds are managed by professionals, which is why it often comes with a high fee, also known as the management expense ratio (MER).

Although a mutual fund can consist of many stocks, it differs from stocks in the sense that investors of mutual funds have no voting rights and funds are measured in units rather than shares. This is why the price of a mutual fund is not referred to as a stock price, but rather as the net asset value (NAV) per share.

The NAV is calculated by dividing the total value of securities in the portfolio by the total amount of units outstanding.

Unlike exchange-traded funds (ETFs), which are traded throughout the day, mutual fund shares are settled at the end of the trading day. Mutual funds have many features, which will be detailed below.

All about mutual funds

One of the greatest benefits of a mutual fund lies in its diversification. Similar to ETFs, mutual funds usually consist of hundreds of securities in a variety of industries. This is beneficial, as a bearish market can be somewhat insulated by the diversification of the fund.

Investors can profit from a mutual fund in multiple ways, such as through dividends on stocks, interest on bonds, capital gains through the selling of stocks by the mutual fund manager and unrealized capital gains whereby stocks increase and are not sold by the fund manager, albeit the gains can be realized by selling your position in the mutual fund.

The most popular mutual fund is the equity fund. It invests primarily in stocks and is further categorized by the market capitalization of the companies it invests in and the style of investment (growth, value or a combination of the two).

Value stocks are those with solid performance, but due to the market are deemed undervalued by the fund manager. Growth stocks are those that have seen tremendous growth in its share price and are expected to continue to increase.

Equity funds are seconded by fixed income funds. As the name suggests, this type of fund focuses on investments that give investors periodic payments such as bonds and other types of debt.

Within this type of fund there are those that focus on high-quality bonds (those issued by stable corporations and governments) and those that focus on low quality bonds (those issued by fledgling corporations, unstable governments and entities with bad credit).

An example

One of the more recent mutual funds is Marijuana Opportunities Series A, which is managed by Purpose Investments Inc. According to its description, the fund “seeks to provide unitholders with attractive long-term capital appreciation by investing in global issuers with interest in the marijuana or marijuana related industries.”

The fund has increased 19.74% since the beginning of the year with a NAV per share of $24.26. The company holds shares in companies such as Aurora Cannabis and Canopy Growth.

Bottom line

Mutual funds are a good choice for investors without much capital who wish to benefit from diversification, as mutual funds typically consist of hundreds of securities.

Despite this, however, mutual funds are notorious for having high management fees, which detract from capital gains. Additionally, those seeking stellar returns may be shocked with the performance of a mutual fund; diversification may limit investors to capital gains, as the strong industries in the fund will be offset by those that perform poorly.

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Fool contributor Chen Liu has no position in any of the stocks mentioned.

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