Mutual Funds, Classifications, Investment Plans, Advantages and Disadvantages, and Myths

Mutual Funds
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Table of Contents
Mutual Funds 
Introduction 
History of Mutual Funds 
How Mutual Funds are Set Up. 
Classification of Mutual Funds 
Investment Plans and Options for Investors 
Advantages and Disadvantages of Mutual Funds 
Advantages of Mutual Funds
Disadvantages of Mutual Funds 
The Mutual Funds Myths 
Mutual Fund Fees and Expenses 
Conclusion
References 
Mutual Funds
Introduction
Mutual fund refers to a trust that pools funds from the investors who share a common financial objective, and invest them in different classes of assets as specified in the investment goal. In other words, a mutual fund is a financial arbitrator, founded with the aim of professionally managing the money collected from investors. Essentially, since the funds are mutual, all of the proceeds, less the incurred expenses, are mutually shared by the genuine investors. The large pool of funds allows investors to the benefits incurred in large economies of scale. For instance, the money can be used to purchase stocks or bonds at a slightly lower price compared to direct investment in capital markets. In addition, mutual fund permits of diversification of portfolios, low costs, flexibility, and convenience. Thus, the mutual fund provides an indirect avenue for investors to invest in capital markets. The fund managers charge a considerable amount of money based on the value of the assets as fees for administering and managing the funds. In a mutual fund plan, investors receive returns that correspond with the amount of money the invested. The units of returns represent an investor proportionate ownership into the assets of the scheme and liabilities in case of losses since the returns are limited to the extent of the money invested by each investor.
The biggest strength of mutual fund is its ability to pool resources. Investors are only required to come up with relatively small amounts of money which are pooled together enabling them to benefit of professionally money management. In addition, the Mutual fund allows small retail investors to access different investment portfolios in the capital market, which they might not be able to access. Fund manager refers to the investment experts who collect money on behalf of the retail investors. The managers are bestowed with the primary responsibility of taking making investment decision relating to identifying and selecting saleable securities and setting appropriate proportionate to investment. The investment decisions are controlled by prescribed rules defined in the objective of the mutual fund. In others words, all investment plan are subject to governing restraints. Also, the governing guidelines help retail investors in selecting the right fund to invest in while considering their investment purpose as well based on the investment goal and patterns.
In the U.S. capital market today, there are always a variety of investment schemes offered by mutual funds that suit different investors’ objective. For instance, risk-averse investors are catered for in schemes characterized by capital protection plans. Another variety of investment plan offers schemes allows a mid and small-cap segment of the market equity that is suitable for aggressive investors since they guarantee capital appreciation. The widespread in investment goals and rights has been significant in classifying and sub-classifying mutual fund schemes. The assets class levels serve as the parameter of classification. Therefore, a mutual fund is categorized into balance funds, gild funds, gild fund, liquid fund, and a bond fund. A further sub-classification categorizes mutual funds into sector funds, index funds, and small cup funds, mid-cap funds among others.
The paper seeks to focus on the understanding of mutual fund by explaining the basics of mutual funds, history of mutual funds, how they are set up, type of mutual funds scheme, their classification based on investment objective. Also, investment plans, benefits of a mutual fund, and the myth of mutual fund myths are discussed in the paper.
History of Mutual Funds
The history of mutual funds dates back to the 18th century. In 1868, Robert Fleming a Briton founded the first investment scheme company known as Foreign and Colonial Investment (FCI). Regarded as the first mutual fund company FCI promised to manage the funds assembled by the Scottish moguls, and invest the funds in diverse securities. Fleming’s investment ideas actually mirrored today’s closed-ended mutual fund. Subsequently, Fleming’s idea rapidly spread across Great Britain and the U.S. as well. In fact, the first open-ended mutual fund in the U.S. known as the Massachusetts Investors’ Trust, was founded in 1924 (Gremillion, 2012). Later, the year 1928 marked a momentous period in the development of the modern mutual funds as firms such as Wellington Fund emerged with new ideas that included concepts of stocks and bond investment. Other forms of mutual funds investment in the USA could still be traced in private trustee schemes in the mid of 19th century in Boston (Gremillion, 2012). Open-ended mutual funds became more favorable and preferable compared to the rivaling close-ended mutual funds immediately after the infamous stock market crash of 1929. The close-ended mutual funds were shunned by investors as they were deemed as highly leveraged.
In terms of regulation, the U.S government introduced the Securities Act of 1933 after noticing the constant fledgling mutual fund industry that was somewhat was uncontrolled. To safeguard investors’ interests, the federal government, through SEC enacted the Security Exchange Act of 1934. Also, it was mandatory for the mutual fund's company to register with SEC as a way of providing prospectus disclosure (Gremillion, 2012). The need for more disclosure began to heap upon the enactment of Investment Company Act of 1940, with the aim of minimizing aspect of conflicts of interest.
In terms of growth and expansion, the mutual fund's industry continued to expand. The number of open-ended mutual funds surged to over 100 towards the end of the year 1949. The mutual fund industry grew tremendously, adding more 50 new finds over a decade after financial markets incapacitated their devastating pre-1929 market crash peak. The rapid growth of the industry was seen the onset of the 1960s as more than 100 new funds worth billions of dollars was established in a net inflow of assets (Gremillion, 2012). Throughout the whole of the 1960s, the appetite of the public for mutual funds was constantly growing until the 1969 bear market subsided (Gremillion, 2012). There was a slight slump as investors cashed out of the schemes, but the industry successively revived later. However, mutual funds became popular recognition in the 19th century, and particularly between the 1980s and 1990s, when the scheme fully captured the public after recording high returns for investors (Gremillion, 2012).
How Mutual Funds are Set Up.
A mutual fund is developed in a form of trust, involving trustees, asset management, sponsors and real custodians. Typically mutual fund is set up by a trustee or more than one trustees who act like a company and registered with the relevant securities of exchange board. In the case of the U.S., the mutual fund company needs to be registered with the Security and Exchange Commission (SEC). SEC is the US independent agency of the U.S. federal government bestowed with the responsibility of regulating security industry by prescribing regulating rules (Hubbard, Koehn, Royer, Ornstein, & Audenrode, 2010). For instance, the regulations outlined by SEC require that at least two-thirds of the directors of a trustee company be independent, and rather not associate with the company’s sponsors. The trust sponsors essentially sign to hold its funds and assets on behalf of the retail investors. The company approved by SEC gains the rights and responsibilities of making investments in different types of securities in its custody (Hubbard, Koehn, Royer, Ornstein, & Audenrode, 2010). The sponsors are vested with a power to act like superintendence and managers as an asset management company. The trustee companies are obligated to operate the mutual fund in compliance with SEC regulations.
Classification of Mutual Funds
Today, investors have abundant choices whenever they think of investing in mutual funds. However, they are expected to understand their separate financial goals and level of risk tolerance to attain their long-term objectives (Haslem J. , 2009). Mutual fund plans can be classified into various distinct categories based on their investment patterns, goals and period of maturity. Based on the maturity period, a mutual fund is classified into three categories, namely open-ended funds. Close-ended funds, and interval fund. The open-ended fund refers to a scheme that allows investors the option to freely subscribe and redeem. In this fund, investors can easily buy and sell units at their net asset value as well as related prices, which are announced frequently (Haslem J. A., 2012). On the other hand, close-ended funds are the plans characterized by fixed maturity period. The fixed periods can be in terms of months of years, for example, 3 months, 6 months, 3 years or 5 years (Haslem J. A., 2012). The fund is considered closed because it is only open for subscription in the prescribed period. In other words, investors are allowed to invest their money in the plan at the time of New Fund Offer (NFO), before is closed. Then, the buyers have the chance to purchase and sell their investment units in the capital market since the units are listed for public subscriptions (Haslem J. A., 2012). Lastly, the interval fund is a scheme that provides features found in both open and closed-ended structure. The planning permit investors to not subscribe and redeem the units in a predetermined period, and at the prevailing net asset value prices. Interval fund has characteristics similar to that of the closed-ended fund but there are some conspicuous differences between them. One of the difference is that, unlike closed-ended fund, interval funds are not mandatory requirements to be listed in the stock exchanges since their redemption window is inbuilt. Another difference is that the interval fund scheme generates new issues of units of the specified duration and the prevailing NAV prices (Haslem J. A., 2012). Lastly, the maturity period in interval fund is not defined as in a closed-ended scheme.
The second classification of a mutual fund is based on investment objectives. These types of funds include equity funds, index funds, gilt fund, liquid funds and hybrid funds. Equity fund also known as growth fund are schemes that provide investors with the option to invest in equity as well as in equity related instrument (Haslem J. A., 2012). The primary aim of such schemes to offer capital appreciation in either medium or long-term periods. The investors that are risk takers and long rangers are suitable for these types of fund plans. Equity funds are further sub-classified into four categories, namely diversified funds, sector funds, thematic funds, and arbitrage funds.
The diversified funds are the ones that comprise a wide range of investment instruments. The aim of this scheme is to reduce the degree of risks in the funds. They are further categorized into large cap, mid cap, and small cap, which are predominantly invested in large companies, mid companies, and small companies respectively (Scott, 2014). There is another related category called multi-cap funds that are majorly invested in all market sizes, that is, large, mid, and small companies. In addition, equity international is another type of equity fund that is invested in foreign countries as it’s the instruments are always diversified across various countries in Europe and Asia to seek for foreign portfolios. Last in this category is the dividend yield fund, also known as equity income (Scott, 2014). This type of scheme is invested in firms characterized by high yielding dividends. In a share’s market context, the dividend yield is defined as dividend per share. Investors use these funds to invest in stocks because they are less volatile due to the companies’ high yielding dividends.
Sector funds are a special kind of equity funds that are accrued in particular sectors are invested in the same sector of the economy. For example, funds accrued in the banking sector will be invested in the banking sector only (Scott, 2014). Thematic funds are the funds that are invested based on the theme existing in the investment. For instance, a fund pooled for information technology purposes will be invested within the shares of companies that are directly or indirectly operating in the information technology industry. Arbitrage funds are the scheme set up to capitalize on arbitrage opportunities, whereby returns are earned to counter the occurrence of risks (Scott, 2014). The plan is executed to capitalize on the effect of prize differential of same assets between two or markets. Essentially, the idea is to take advantage of the common mispricing occurrences between market derivatives and cash. The arbitrage funds are characterized by low risk-return in the trade-off.
Index funds are another objective oriented fund that is invested in companies that are made of the index and in equal proportion with the goal of replicating an index of a particular market. As a result, a rate of return that is matched with the market will be generated. Another is one is the income or debt oriented funds (C., 2015). This types of plan allow direct investment in debt portfolios such as debentures, government securities, treasury bills, and debentures. Gilt funds are the one invested specifically in government securities because they do not default. In addition, the net asset value of gilt funds is prone to fluctuations due to constant changes in economic factors and interest rates especially in an income or debt oriented plan. Another type of fund in this category is the money market, also referred to as liquid funds (V. Terraza, 2013...