Many people have managed to save more than usual during the pandemic and are now wondering what they can do to earn more money with what they already have. One of the easiest options is to find a bank that pays you for having money in an account. In this case, One of the most profitable options is to add part of our savings to an investment fund. But what are mutual funds? How do they work?
We want to clarify the concept of mutual fund and explain well how it works. It is also advisable to know the different types that exist to know which one can be better for us. If you are interested in the topic, keep reading.
What is an investment fund and how it works?
When we speak of a mutual fund or an investment fund, we refer to an IIC (collective investment institution). It is based on the gathering of various investor funds to invest them in different financial instruments. Responsibility for this action is delegated to a management company. This can be an investment services company or a bank. In other words: Mutual funds are a diversified alternative investment, as they invest in different financial instruments thus reducing risk (depending on the type of investment fund chosen).
People who contribute a part to the fund are called fund participants. The contribution of all of them forms a patrimony administered and managed by a management company and by a depositary entity, whose function is to safeguard both the cash and the securities. It also performs other functions such as monitoring and guaranteeing investments.
After investing in one of these funds, the participant obtains a certain number of shares. These have a different net asset value or price each day, as it is the result of the division between the equity valued at the time and the number of existing shares. To obtain the return on the investment fund, you have to sell the shares. Generally, the sale can be made at any time, except in those funds in which liquidity is limited to certain periods or dates.
Operation
Several people get together creating a joint fund in a depository entity, such as a bank, whose sole purpose is to safeguard money or assets. The investment fund is managed by a management company specialized in investments. The participants, that is, the people who have put money in the fund, get their investment percentage the day they want to get their money out of there. The profitability will depend on the results of the management company who has been investing that money in various financial instruments.
Normally, the management company invests in money (foreign or local currency), in real estate or assets assigned to an operation (which would be mortgage bills) and in listed securities (bonds, shares, etc.). In addition to investing the capital, it is also in charge of keeping the accounts, controlling the depository company and making legally required publications. On the other hand, the sole function of the depositary company is to guard the instruments and securities representing the investments. Both companies must control that all the guidelines of the management regulations are met.
In conclusion, mutual funds or investment funds offer medium and small savers the possibility of increasing their savings through participation in the capital market. They do this with the same professionalism and criteria as large investors.
Types of investment funds according to their performance
There are two different classes of funds, depending on their performance. In the first place there is the relative one, whose performance is related to an index, also called Benchmark, and is achieved in a certain time. These are the most traditional investment funds whose investments are less risky, but they also have less commissions.
In the case of the absolute class, there is no Benchmark and the value of the investment is measured by its monetary value. Investment funds of this type are quite expensive and the participant does not know what they are going to invest in. They usually use all kinds of investment techniques, such as derivatives, short positions, etc. that increase the risk of the investment.
Relative performance
When we talk about investment funds with relative performance, the participants have knowledge of both the geographical area where they will invest and the financial instrument, such as raw materials, stocks, stock index, bonds, etc. They are also informed when the decision is made to focus on a specific sector of the market, such as technology, pharmaceuticals, etc. What's more, set the value using a Benchmark which is usually related to a certain stock index. Relative performance can be divided into two groups, depending on management:
- Active management: Traditional investment funds whose cost is usually 2% of commissions of what is invested.
- Passive management: Index funds that replicate an index and whose cost is around 1% of the investment and Exchange-Traded Fund (ETF), which also use advanced investment techniques and its cost is 0,5% of the investment.
Absolute performance
Generally, the absolute yields are managed by brokers. In these cases, the investors do not know exactly what they intend to invest in. What's more, the investment techniques they use tend to be more speculative, thus increasing the risk. In these cases there are the following funds:
- Hedge Fund or Hedge Fund: They are funds for institutions such as large estates or other investment funds. The commissions are high and the risk very high, as they can get into debt to make high-risk investments, such as short positions.
- Alternative management funds: They have a high return, but the risk is also high.
What is the best investment fund?
It is very difficult to say which is the best investment fund, as it will depend on the situation of each person. Therefore, there are a large number of different types. They can be classified according to their risk, investment vocation, geographical area or type of return. However, the most popular is the one for investment vocation. Within this category these types stand out:
- Fixed income investment funds
- Equity investment funds
- Global investment funds
- Mixed investment funds
- Funds of funds
- Guaranteed funds
- Hedge Funds (hedge fund or alternative management funds)
- Index funds or index funds
- Monetary investment fund
I hope this article has helped you understand what mutual funds are. They are a good alternative for those who do not understand the market too well or who simply do not have time to be up to date, but who want to put their money to work anyway.