Most people opt to invest in mutual funds with the goal of earning high returns. They also hope to beat inflation. And since professionals who are highly skilled at managing financial investments run them, mutual funds ought to always make money, right?
Mutual funds can be profitable investments, but they can also fail when not invested wisely. Failure can happen if mutual funds are invested for the short-term, fail to diversify, or if the management underperforms. Mutual funds’ value could also rise and fall following changes in the stock market.
In this article, I will expound further on a few topics related to mutual funds and their profitability. We will discuss how mutual funds make a profit and scenarios in which they might fail to do so. Additionally, I will also share a few tips and considerations to make when investing in mutual funds. So, let’s begin!
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Table of Contents
How Do Mutual Funds Make Profitable Returns?
Mutual funds make high returns when they’re invested wisely, and the securities in their portfolio go up in value. As such, mutual funds make money from:
- Dividends. Members of a mutual fund receive dividends when specific stocks or bonds that the fund invests in make payouts. Though not all stocks give dividends, those that do pay them out quarterly, and you can choose to reinvest them and buy more shares.
- Capital gains. This occurs when a fund sells security whose price has gone up. This means the security sells for a much higher price than the amount the fund originally paid for it.
- Increase in the fund’s share price (Net Asset Value). A fund’s share price goes up as the value of the mutual fund increases. Should you choose to sell your investment or part of it, you would make a profit.
The above shows that if you invest in a well-managed fund, you are most likely to make positive returns. But how does this actually happen? Let’s look at the reasons behind the favorable returns.
6 Reasons Most Mutual Fund Investments Are Profitable
Discussed below are the six top reasons that make most mutual fund investments profitable in the long run:
Mutual Funds Use Skilled Professionals
Mutual funds can be profitable because skilled professionals manage them. These funds rely on the skills and expertise of professional fund managers who invest your money based on informed decisions.
Fund managers not only manage investors’ funds but also have a dedicated team working under them. The professional team carries out extensive market research on market trends and viable investment opportunities and keeps track of portfolio performance.
Sure, some people may tell you that investing directly in stocks is better as it provides a unique opportunity to make high returns while staying ahead of inflation. But not everyone has the time, know-how, or financial acumen to select profitable shares and track their performance. Fortunately, mutual funds do.
Mutual Funds Offer Opportunities for Wealth Creation
Not all mutual funds are safe investments, and some can be even riskier than traditional stocks. Because of their high risks, mutual funds can offer investors the opportunities to make more money and accumulate more wealth. Such funds include high-yield stock and bond funds.
Others like balanced funds that invest in stocks and debt offer stability while still giving you the chance to win significant gains.
Mutual Funds Diversify Their Investments
Mutual funds invest in securities from various sectors. Therefore, investing here means that you get to diversify your portfolio, thus spreading your risk across multiple assets and sectors.
Diversification also minimizes your risk if one industry fails to perform as well as expected and ultimately contributes to wealth creation.
Mutual Funds Are Tax Efficient
Mutual funds tend to be more tax-efficient than traditional investments since the tax on short – and long-term gains don’t impact the fund’s returns in a big way. Moreover, tax-efficient returns coupled with beating inflation make mutual funds the preferred investment option for savvy investors.
Mutual Funds Have a Long-term Investment Horizon
When you invest in a mutual fund for the long term, you stand to earn more profits because of the magic of compounding. What this means is that your interest earns more interest if you keep reinvesting your profits. This investment horizon typically covers a minimum of 10 years; thus, you can afford to take more risks with your investments, such as investing in growth funds.
Mutual Funds Have Low Transaction Fees
Since mutual funds pool money from multiple investors with similar objectives and then invest the funds, their transaction costs are lower. The net effect is that the cost of investing in a mutual fund is low when compared to traditional investments.
And so, even with limited capital, you can still invest in bonds and equities.
When Are Mutual Funds Not Profitable?
Mutual funds can fail to make reasonable profits under the following circumstances:
- If the fund manager underperforms.
- If investors fail to invest for the long term.
- If the fund runs out of money.
- If the fund’s sales charges and expense ratios get too high.
- If there is an abuse of office by management, such as through unnecessary trading.
- If the fund invests heavily in short-term investments such as high-yield funds since their income attracts higher taxes.
How To Ensure Your Mutual Fund Investment Remains Profitable?
Mutual funds can be profitable and earn you consistent returns if you pick the right fund and invest appropriately. To achieve this, you need to do the following:
- Pick the right mutual fund. To choose the most suitable mutual fund, consider factors such as past performance, fund size, management type, investment portfolio, and expense ratio.
- Always diversify your holdings. Check that your potential mutual fund has a solid portfolio with investments in different assets. In other words, avoid choosing a fund that invests in a single sector or industry since a fall in price in the sector could affect your entire investment.
- Confirm what the applicable fees are. Fees can reduce your profits, so you want to ensure there are no hidden charges. For better returns, go for no-load mutual funds. These are funds that do not charge sales commissions when you buy or sell fund shares, thus giving you higher returns.
- Invest based on your goals. Your investment can be profitable if you invest based on your financial objectives. Clear goals provide guidance on choosing the right fund, how much to invest, and for how long. And since there are several mutual fund products available, including shares, bonds, and money market securities, you want to select one based on your risk profile too.
- Be consistent. Make sure you invest regularly by setting up automatic monthly payments. Doing so allows you to take advantage of systematic investment plans which promote disciplined investing, helping you meet your financial objectives.
One thing to note is that instead of sticking to their investment plans, some investors focus a little too much on a mutual fund’s past performance. This is a risky move because once you buy into a fund after learning about its outstanding performance in the previous year, you are bound to get into trouble.
You see, past performance is never a guarantee that future performance will be just as good. It is thus not advisable to chase performance. Rather you should check to see whether the fund’s investment strategy matches your objectives.
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Conclusion
While there is no risk-free investment, a mutual fund enables you to earn good returns through the power of compounding. It is also less risky than a direct investment in shares, and you rely on the expertise of a professional fund manager. Thus the longer you invest, the higher your potential earnings.
That said, management fees can take a chunk off your earnings. Hence, the best approach is to choose a fund that conducts reasonable asset allocation as well as portfolio management without charging high fees.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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