What are Mutual Funds?

Out of the many investment options available on the market, mutual funds can be a beneficial portfolio addition for investors looking to diversify their holdings. However, potential investors may not have an adequate understanding of how mutual funds work and hence, may end up passing on this investment opportunity altogether.

So, what exactly are mutual funds? Simply put, mutual funds are investment vehicles that pool money from many individuals and invest it in a basket of securities, including various asset classes like stocks, bonds, debt instruments, and commodities. Mutual funds are managed by professional fund managers who ensure the fund’s asset allocation is aligned with the investment strategy.

How Do Mutual Funds Work?

Each investor buys one or more shares in such funds; these shares represent their part ownership in the fund and any income it generates. Customers purchase such shares at a price called the fund’s net asset value (NAV), which changes every day. It is calculated daily by dividing the total value of securities in the portfolio, less any liabilities, by the total amount of shares outstanding.

Types of Mutual Funds to Invest In:

There are several different types of mutual funds available to investors in the UAE. These are usually classified according to the underlying asset class. Popular categories include stock or equity funds, bond or fixed-income funds, money-market funds (which invest in short-term debt securities such as US Treasury bills), commodity or commodity-linked funds, hybrid funds and so on. Investors may also explore investment vehicles to capitalize on real estate, Sharia-compliant Islamic products and more.

Sometimes, funds may be categorized according to how they are administered. Passively managed funds track the performance of an index or benchmark. Actively managed funds rely on a Portfolio Manager or team to decide how underlying assets may be allocated, usually with the aim of performing better than a stated benchmark.

Benefits of investing in mutual funds

Regardless of the underlying asset class, mutual funds offer many advantages for investors, including:

• Simplicity: Mutual funds are easy to understand and access. Not only do they require low minimum investment amounts, they are only priced once a day, eliminating intra-day price fluctuation and uncertainty, as well as bid/ask spreads which add to the associated costs of a transaction.
• Diversification: Like putting all your eggs into one basket, putting money into a single stock or bond exposes investors to underlying issues at those organizations, for example bad management. With the same amount of money, investors can access many different assets via a mutual fund. This diversification brings with it a lower asset risk. Losses at one company can therefore be offset by other outperforming assets in the portfolio.
• Easy access: Most funds can be bought and sold at any time. You simply need to redeem your investment at the day’s NAV, allowing easy access to emergency funds at short notice. As such, mutual funds are considered liquid investments.
• Wide choice: Mutual funds are available in nearly every investment market around the world. In a sense, these funds bring even the most expensive assets within reach.
• Expert management: Juggling the demands of work, life and family means most people don’t have the time to explore and monitor different investments – or the knowledge to learn about them. With actively managed mutual funds, fund managers do the work instead, buying securities according to predefined investment principles, and tracking and readjusting the portfolio as required—all to maximize investor returns. So, if you’ve just received a bonus or collected a little cash that’s sitting in your savings account, you may want to consider actively managed funds instead.

Disadvantages of mutual funds

It is important to note that mutual funds do carry drawbacks. Some funds may carry high expense ratios. An expense ratio that is the measure of how much of a fund’s assets are used for administrative and other operating expenses.

Secondly, although investors are usually aware that invested capital and future returns are not guaranteed, actively managed mutual funds may fail to meet the returns of their benchmark overtime, thereby performing worse than the underlying market. This is where it pays to evaluate a fund’s ratings, and to consult a professional financial expert.

Finally, the large number of mutual funds available can lead to choice paralysis, where choosing a fund is tedious. Again, consulting a financial planner can help you determine the right investment strategy based on your profile and goals.

Choosing mutual funds that are right for you

Don’t let the number of mutual funds available put you off this potential route to improve your finances. Instead, consider these simple points before you make your decision

1. Values: Pick a fund with a philosophy in line with your own and think about its underlying assets. You may not like the volatility of the share market, for instance, preferring property or gold instead. Read up on different mutual fund houses here.
2. Background: Do read up on any funds you may be considering. Each fund must publish a factsheets and prospectus, which detail its objectives, rating, and past performance. Remember that past performance is no indicator of future returns.
3. Management: For deeper insight, consider who the Portfolio Manager is, and find out about him or her. You’re actually buying the fund manager’s track record, so check that the same person continues to manage the fund in question.
4. Advice: It’s okay not to understand everything about the funds you want to buy. That’s why it makes sense to turn to a financial consultant, such as your bank’s relationship manager. Be open about your goals, and you’ll quickly be advised about appropriate possibilities.

How to invest in mutual funds in the UAE

Perhaps the easiest way to buy into mutual funds is a systematic investment plan (SIP), available through brokers and banks in the UAE. Such a plan eases the investment process considerably by allowing you to put away a small but fixed amount at regular intervals, instead of waiting to collect a lump-sum. As an investor, you simply decide how much you think you should be setting aside to achieve your future goals—and can instruct your bank to automatically transfer the money to the fund of your choice. Typically, such systematic transfers are timed for once a month, although in some cases you could set up a SIP with weekly or fortnightly debits.

Taking out a SIP makes sense for several reasons:

1. Dollar cost averaging: By investing a fixed amount of money regularly over a predetermined period—for example, each month over three years—you benefit from fluctuations in a fund’s NAV. While you may buy high today, the fund price could have dropped significantly before your next purchase. With regular payments, you buy fewer units when markets are high and more units when prices are low. The process, called dollar cost averaging, brings down your average cost and reduces your exposure significantly.
2. Peace of mind: Everyone wants to buy low and sell high. But it’s extremely difficult to determine when the market for any asset has reached its lowest point. Even the smartest investors may see their investment decline in value and respond emotionally. SIPs eliminate this urge by promoting a rational investment attitude.
3. Compound effect over time: Small, regular investments can generate much higher returns than lump-sums put away at erratic intervals, especially if you reinvest any returns along with new SIP payments. Thanks to the power of compounding, those disbursements in turn earn you money, accruing enormous value over time.
4. Achieve your goals: Whether it’s your children’s education or the creation of a retirement corpus, systematic investments can help you realize otherwise daunting financial goals. Like the ant in the classic fable of the ant and the grasshopper, storing small amounts over time generates enough to make large payments easily in the future.
5. No lifestyle disruption: Because each SIP payment is a small amount—you don’t need to alter your lifestyle dramatically. A few tiny changes to your everyday life can pay off handsomely over the long term.
6. Automated payments: With direct debits, it’s easy to save regularly. Simply instruct your bank to transfer the SIP payment each month—that way, you don’t forget to save, nor do you miss a payment.

Pooling your assets with other investors in a mutual fund offers puts otherwise inaccessible asset classes within easy reach. Doing so regularly and systematically can help you amass wealth in a methodical and efficient way. Additionally, investing in mutual funds offers investors a simple way of diversifying their portfolios with the expertise of a professional fund manager. For more information on how you can benefit from mutual funds, look into Citibank’s Systematic investment Plan (SIP). With a tenure of only 36 months, it offers the ability to stop contributions at any time. Setting up a SIP is also convenient and can be done from the comfort of your laptop through Citibank Online. Click here to begin.

Disclaimer: Investment products: Not a Bank deposit. Not Government insured. No Bank guarantees. May lose value.