Mutual funds in 2025: How do they work? What is the best investment? What should I pay attention to?

02, Jul - REVIEWS

In search of effective ways to increase capital, many people are faced with the need to deeply understand the intricacies of financial markets. However, not everyone has the time and knowledge to constantly analyze stocks, bonds, currencies and other complex instruments. This is where mutual investment funds come to the rescue - one of the most popular and accessible instruments for collective investments, allowing even beginners to enter the financial market under the guidance of professionals. But what are they, how do they work, and how to choose the mutual investment fund that is right for you? Let's look into the details.

What are mutual investment funds and why are they so popular?

In essence, mutual investment funds (abbreviated as mutual funds) are a form of collective investment, in which the money of many investors is combined into a single pool and then managed by a professional management company. This company, acting in the interests of all shareholders, invests the collected funds in various assets: stocks, bonds, real estate, cash and other instruments, in accordance with a predetermined investment strategy of the fund.

Each investor who contributes money to the fund acquires a share - a share in the total property of the fund. The value of the share changes daily depending on the market value of the assets included in the fund. When the value of the fund's assets rises, the value of the share rises, and when it falls, its value falls. It is the growth in the value of the share that is the main source of income for the investor.

Why are mutual investment funds so popular? There are several reasons:

• Access to professional management: You do not need to be an expert in finance. Experienced portfolio managers work for your money, making investment decisions, analyzing the market and managing risks.

• High diversification: Even with a small amount, you get access to a wide portfolio of assets. For example, when buying a share in a stock fund, you are actually investing in dozens or hundreds of different companies, which significantly reduces risks compared to buying shares of one or two companies.

• Low entry threshold: You can start investing in a mutual fund with relatively small amounts, which makes them accessible to a wide range of investors.

• Time saving: You do not need to independently monitor the markets, make decisions about buying or selling assets. All this is done by the management company.

• Transparency: Mutual investment funds are regulated by the state, and they are required to regularly publish information about the composition of their portfolio and the value of the unit.

Thus, a mutual investment fund is an excellent tool for those who want to invest in the stock market, but do not have sufficient knowledge, time or large starting capital for independent trading.

How mutual investment funds work: Mechanism of operation

Understanding the inner workings of a mutual investment fund will help you make more informed decisions. The functioning of a mutual investment fund includes several key stages and participants.

1. Creation and registration of the fund: The management company (MC) makes a decision to create a mutual fund, determines its investment strategy, fund type, issues an investment declaration. Then the fund is registered with the regulatory authority (for example, in Ukraine this is the National Commission on Securities and the Stock Market).

2. Raising funds: Investors (individuals and legal entities) purchase fund shares from the management company or its agents (banks, brokers). Each share is a certain share in the total property of the fund.

3. Asset management: After raising funds, the management company invests them in accordance with the stated investment declaration of the fund. This can be the purchase of shares of various companies, government or corporate bonds, real estate, or even precious metals. The goal of the management company is to achieve growth in the value of the fund's assets.

4. Calculation of the unit value: The net asset value (NAV) of the fund is determined daily (or at other established intervals). This is the total market value of all the fund's assets minus all liabilities. The NAV is then divided by the number of issued units to obtain the calculated value of one investment unit. This value is a guideline for buying and selling units.

5. Purchase and redemption of units: Investors can buy new units from the management company at the current calculated value. They can also redeem (sell) their units back to the management company at the current calculated value, receiving their money. This provides investors with liquidity, albeit with a certain delay depending on the type of fund (open, interval, closed).

6. Control and reporting: The activities of the management company and the fund are under strict control of the regulatory authority, as well as specialized organizations, such as a specialized depository (stores the fund's assets) and an auditor (checks the reporting). Mutual investment funds are required to regularly publish their reports, which ensures transparency for shareholders.

Key point: the profit that a mutual investment fund receives from the growth in the value of assets or received dividends/coupons is not distributed among shareholders directly, but is reinvested back into the fund. This leads to an increase in NAV and, accordingly, an increase in the value of each share. You make money when you sell your share for more than you bought it for. This is a fundamental difference from dividend stocks.

What is better to invest in: Types of mutual investment funds and their purpose

Choosing a suitable mutual investment fund is no less a responsible matter than choosing individual shares. The variety of types of mutual investment funds allows investors to choose an instrument that meets their goals and risk tolerance.

The main types of mutual funds by investment type:

1. Equity funds:

   • What they invest in: Shares of public companies.

   • Risk/Return: High return potential, but also high risk. Their value is most sensitive to stock market fluctuations.

   • For whom: For long-term investors who are prepared for significant fluctuations and have a high risk tolerance. For example, to save for retirement.

2. Bond funds:

   • What they invest in: Government and corporate bonds.

   • Risk/Return: Average risk, moderate return. More stable than stock funds, provide regular, predictable income.

   • For whom: For conservative investors who value stability and capital preservation, as well as for diversifying a risky portfolio.

3. Mixed investment funds:

   • What they invest in: A combination of stocks and bonds, sometimes with the addition of other assets (real estate, cash). The ratio can change depending on the market situation (active management) or be fixed.

   • Risk/Return: Moderate risk, balanced return. They are a compromise between the risk and return of stock and bond funds.

   • For whom: For investors with a moderate risk tolerance who are looking for a balanced approach without having to choose between stocks and bonds.

4. Money Market Funds:

   • What they invest in: In highly liquid and short-term money market instruments (bank deposits, short-term bonds).

   • Risk/Return: Minimal risk, low return, but higher than bank deposits.

   • For whom: To preserve capital for the short term, as a "parking lot" for money, or as an alternative to deposits.

5. Real Estate Funds:

   • What they invest in: Commercial or residential real estate, or securities of real estate-related companies.

   • Risk/Return: Medium risk, potential for stable rental income and growth in the value of the properties.

   • For whom: For investors who want to gain access to the real estate market without having to buy physical properties.

6. Industry Funds:

   • What they invest in: Shares of companies in a specific industry (e.g. IT, biotechnology, energy).

   • Risk/Return: High risk (due to concentration in one industry), but also high growth potential if the industry is thriving.

   • For whom: For investors who believe in the potential of a particular industry but want to diversify within it.

When choosing a mutual fund, always focus on your personal financial goals and comfort level with risk.

What to look for when choosing a mutual fund?

Choosing the right mutual fund is not always an easy process, given the variety of them. To ensure that your mutual funds are successful, it is important to conduct a thorough analysis. Here are some things to pay attention to:

Management company (MC):

1. Investment strategy and investment objects:

   • Carefully study the fund's investment declaration. What exactly will it invest in? Does this strategy fit your goals and risk appetite?

   • Some mutual funds may invest in exotic or high-risk assets that you should be aware of in advance.

2. Performance Metrics:

   • Historical Performance: Explore how the fund has performed over the past 1, 3, 5, and 10 years. It is important to remember that past performance does not guarantee future performance, but it does give an idea of ​​the effectiveness of management.

   • Peer Comparison: Compare the fund's performance to similar funds and to the benchmark (the market index it is trying to "beat").

3. Fees and Expenses: This is one of the most important aspects that is often overlooked. Fees can eat into your profits significantly.

   • Markup: The fee you pay when you buy shares (can be 0-5%).

   • Discount: The fee you pay when you redeem shares (can be 0-3%).

   • Management fee: An annual percentage of the fund's net asset value for management (usually 0.5-3%).

   • Other expenses: Depository, auditor, registrar fees.
     Choose a mutual fund with reasonable fees. Even a small difference in percentages can make a huge difference in the long term.

4. Fund size: Large funds are usually more stable and have a larger volume of assets, which allows for better portfolio diversification and more efficient management of funds. Funds that are too small can be riskier or inefficient due to high management costs per unit.

   • Reputation and experience: How long has the management company been operating on the market? Does it have any successful cases? Read reviews.

   • Reliability: Check the management company's licenses, the absence of lawsuits or claims from the regulator.

   • Management team: Who manages the fund? What is their experience and qualifications?

5. Liquidity of units:

   • Open-end mutual funds: Units can be bought and sold on any business day. Most liquid.

   • Interval mutual funds: Units can only be bought and sold at certain "intervals" (for example, once a quarter). Less liquid.

   • Closed-end mutual funds: Units are purchased when the fund is formed and can only be redeemed at the end of the fund's term or sold on the secondary market. Least liquid. Choose the type that suits your needs for access to funds.

A careful analysis of these factors will help you make an informed choice and find the mutual fund that will help you achieve your financial goals.

The Benefits and Risks of Investing in Mutual Funds

Like any financial instrument, mutual funds have their strengths and weaknesses. Understanding them will help you make informed decisions and adequately assess potential results.

Advantages of Mutual Funds:

1. Professional Management: The main advantage. Your investments are monitored by experienced analysts and managers, which frees you from the need to deeply study the market and make daily decisions.

2. High diversification: Mutual funds allow you to invest in a wide range of assets, even with a small amount. This significantly reduces the risk associated with a fall in the value of individual securities.

3. Low entry threshold: You can start investing with a few thousand hryvnia, which makes the funds accessible to a wide audience.

4. Liquidity (for open-end mutual funds): The ability to quickly sell your shares and get your money back, which provides flexibility in capital management.

5. Transparency and regulation: The activities of mutual funds are strictly regulated by law, which ensures the protection of investors' rights and obliges funds to regularly publish reports. This reduces the risk of fraud.

6. Access to complex instruments: Some mutual funds invest in instruments that are inaccessible or too complex for individual investors (e.g. international markets, derivatives).

Risks of mutual funds:

1. Market risk: The value of shares depends on fluctuations in the prices of the assets included in the fund's portfolio. If the market falls, so does the value of your shares. No mutual fund guarantees a return.

2. Manager risk: Despite regulation, there is always a risk of poor management, managerial errors, or, in rare cases, fraud.

3. Fees: As mentioned earlier, high fees can significantly reduce your actual return, especially over the long term. It is important to carefully study the structure of all fees.

4. Liquidity risk (for interval and closed-end mutual funds): The inability to quickly sell shares and get money if an urgent need arises.

5. Lack of direct control: You trust your money to the management company and cannot influence its investment decisions or the composition of the portfolio.

6. Taxation: In some jurisdictions, income from mutual funds may be taxed, which also affects the net return. It is important to clarify the tax regime in advance.

7. Inflation risk: If the fund's return is lower than the inflation rate, the real purchasing power of your money will decrease.

Remember that investing is always associated with risk. However, a smart approach and choosing the right mutual fund will help you effectively manage these risks and achieve your financial goals.

Conclusion: Mutual Funds – Your Step to Financial Independence

Mutual funds are a powerful and convenient tool for those who want to increase their capital, but are not ready to devote all their time to studying stock markets. They offer access to professional management, wide diversification and a relatively low entry threshold, which makes them attractive to both beginners and experienced investors.

However, before investing, it is extremely important to carefully study each mutual fund: its investment strategy, historical returns, fee structure, reputation of the management company and type of liquidity. A conscious understanding of potential risks and benefits is the key to successful investing.

Remember that investing is a marathon, not a sprint. Patience, discipline and regular monitoring of your investments, even if they are backed by a professional team, will help you achieve the financial results you desire and make mutual funds an effective tool on the path to your financial independence.