Why South Africans invest in mutual funds? A mutual fund holds a large group of stocks that are managed on behalf of investors in the fund. This allows an investor to diversify his portfolio without the high transaction fees required to buy many different stocks.

One thing almost all financial advisers agree on is the recommendation to build a diversified portfolio. What is the advantage of building a diversified portfolio? It offers protection against big losses due to the action of one or two individual stocks. If a portfolio is spread across 20 stocks, a steep loss in one of the stocks will not bring down the entire portfolio.

Small investors often don’t have the funds to buy a variety of stocks. Mutual funds give small investors a way to achieve the benefits of diversification with a small amount of money.

Mutual funds can hold a variety of securities including common stocks, corporate bonds, government bonds, treasury bills, even options and futures. Each fund generally has a specific investment approach, which largely determines what type of securities it will hold. There are growth funds that seek to invest in rapidly growing companies that usually pay no dividends. There are income funds that invest in mature companies that pay high dividends. There are funds that invest in natural resource companies, funds that invest in computer related stocks, and funds that invest in foreign companies. There is a mutual fund for almost any investment approach you can think of.

A mutual fund is actually a holding company and investors in the fund are buying shares of the company. There are two basic types of mutual funds. Load funds and “no load” funds. Shares in no load funds are generally purchased directly from the fund and no commission charge is collected. Load funds are sold through brokers who collect a commission on the transaction. There is no evidence that load funds as a group, perform better than no load funds.
Most funds are actively managed in an attempt to respond to changing investment conditions. The portfolio managers seek to rotate holdings in the fund in a way that will outperform the major market indexes.

Over time however, not many funds achieve this goal. So there are also index funds, which simply invest in the stocks that make up a market index, such as the Standard & Poors 500 index. Investors in an index fund are guaranteed to achieve results similar to those of the index.

Management fees are generally deducted from the total assets of a fund. Management fees vary between funds but since index funds are managed in a more simple way they generally have lower management fees. This gives index funds a slight advantage in that component of capital preservation.

Mutual funds are generally used for establishing a medium to long-term position in a market sector, but for traders who have shorter term trading strategies there are closed end funds and exchange-traded funds (ETFs). These funds are traded on the major exchanges just like stocks, and so allow easy entry and exit.