What are mutual funds and how do they work?

Elaine King

There are many investment options out there, and one of them is mutual funds. This kind of fund works according to the increase of value or capital appreciation in the sector in which you invest your money. Because mutual funds carry some risk, it's important to know which fund best suits your needs before making a decision. Understanding the characteristics of various financial instruments will help you choose the one that will really give you the best benefits.

How does a mutual fund work?
Financial institutions gather the contributions of various investors and, through fund managers, invest these contributions in different financial instruments (such as bonds or shares). The administrator must choose where and how much to invest, and the idea is to invest in those that can deliver more value and thus increase the capital.

It's important to consider two characteristics before choosing a mutual fund:

What type of mutual fund is it?
The mutual fund is defined according to the mix of financial instruments used and the investors's profile. There are fixed income funds, and the investment is usually given in corporate, treasury or international bonds, etc. This type of fund offers the advantage of a moderate risk compared with the equivalent equity fund. On the other hand, equity funds invest in instruments such as shares in listed companies, implying a much higher risk, but very interesting profit possibilities, as well.  Remember that taking more risk means the possibility of higher profits and greater losses.  It all depends on your risk tolerance and the years you'll have to recover from volatile market cycles.

Finally, mixed funds combine the ones we mentioned earlier and offer a greater balance between profit and risk.

There are also international funds that focus on instruments traded in the foreign markets. You can also find short-term ones. New products are created every year, so making an appoinment with a certied financial planning advisor at your financial institution that will explain every one of them is a good way to make a decision that you will benefit from.

Historical profitability
An interesting reference to decide which fund to invest in is profitability and historic risk. Although it doesn't guarantee anything, it can give us a guideline to assess the abilities of the Fund Administrator and its structure. To use historical profitability as a reference, it's best to consider long periods of time (minimum three years) before making a decision, because the specific conditions of a year (such as electoral periods or national economic crises) can vary the results considerably.  Remember that historical profitability does not guarantee future results.

Informing yourself before making a decision is an important responsibility that will help you make your money grow and protect it from the market's contingencies.

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Elaine King - Family and Money Matters™ 2021