A sound investment plan is an essential part of a financial strategy to enable a savvy investor to build wealth over a period of time. In today’s world, the goal is not simply to get by financially, but instead to systematically generate wealth, and one way of doing this is through mutual funds. Mutual or investment funds are professionally handled (whether actively or passively), open-ended products that pool money from multiple investors to purchase securities, also known as financial assets or instruments. An open-ended scheme is simply one that is available for subscription and repurchase on a continuous basis with no fixed maturity period. So, mutual funds invest in stocks, bonds, and other assets, and each investor in the fund owns shares in the combined holdings or portfolio.

Types of mutual funds

There are typically four types of mutual funds: Equity (stocks), fixed-income (bonds), money market funds (short-term debt), and hybrid, or balanced, funds (both stocks and bonds).

The type of fund you invest in will be determined by your goals and objectives. The aim of every mutual fund is to spread around risk even while trying reaping wider market gains. To find a mutual fund that is an appropriate investment for you, you must first be clear about your investment goals. Do you want long-term capital gain or current income? Are you thinking about funding college expenses for you or your children? Or are you thinking about down the road for your retirement? What’s your risk appetite? Are you from the school that accepts that the higher the risk, the higher the reward? Or are you more conservative in your outlook?

It can be overwhelming trying to decide which funds are right for you because there are so many, but that’s where a fund manager comes in, after you have articulated your investment objectives, to help you narrow down your choices and make decisions about how to allocate assets in the fund.

Which fund is best for you?

As with any investment decision, it is important to do your homework thoroughly.

Say you’re risk-averse and want to use the money in the short term, then you’ll want to focus on safety. An equity fund comprises stocks or publicly traded shares of a company. When you invest in this type of fund you own a little piece of all the entities the fund invests in. The equity fund has a higher potential for growth but also a higher potential for volatility, might not be the fund for you, especially if you’re not as young and thus able to weather the vicissitudes of the market.

Bond funds, meanwhile, are common fixed-asset mutual funds in which investors are paid a fixed amount back on their investment. These funds don’t buy stock, but rather invest in corporate and government debt, so you are in effect lending your money with the expectation you will be repaid. However, they have less growth potential and so usually considered a safer investment. These funds are better for investors nearing retirement.

Money market funds, too, are considered safe investments, and are often thought to be even worse than bond funds for building wealth. But they invest in high-quality, short-term debt from governments and such entities as banks and corporations and, for what it’s worth, can be thought of as a forced savings plan.

Meanwhile, hybrid/balanced funds are thought to be asset allocation funds or a combination of equity and fixed-income with a fixed ratio of investments, such as 60 per cent stocks to 40 per cent bonds.

Advantages & disadvantages

While they may be now enjoying increased popularity, mutual funds have been around for a long time. They are becoming increasingly appealing largely because they offer investors the ability to, with the purchase of just one single fund, diversify across many investments, thus spreading around risk. Another plus is that mutual funds offer investors a chance to reinvest dividends, therefore making the initial investment grow even more. Also, there is no good or bad time to start investing, unlike with stocks, as the decision to buy and sell is left to the fund manager’s expertise. Another big plus is that mutual funds have great inherent potential to perform well over the long term, satisfying your long-term goals.

On the other hand, some disadvantages include high administrative and operating costs which may reduce the return to investors. But these management fees can be seen as a small price to pay for professional help from a portfolio manager overseeing your investment portfolio if you’re not trained to do so.

Also, another disadvantage is they lack liquidity. But is this even really a disadvantage? Selling a mutual fund will give you access to your money the day after. With stocks and other closed-end funds you will wait a day or so more to get your cash. For more liquidity you might as well bury your money in a hole in your backyard.

Making smart investment decisions will affect your financial well-being. Mutual funds overseen by a reputable fund manager, as part of your investment plan, have the potential to build wealth and secure your financial future.