Mutual funds are investment vehicles that are comprised of different types of holdings. The rate of return on mutual funds indicates how fast value in the fund accumulates. The Securities Exchange Commission (SEC) warns that just because a fund has done well in the past there is no guarantee that it will do well in the future. However, past performance can be helpful in evaluating some aspects of the fund, particularly its volatility.
Mutual Fund Basics
A mutual fund is actually an investment company. Money from investors is used to purchase stocks, bonds, money market holdings and other types of assets for the purpose of increasing wealth. The combined holdings of a mutual fund are referred to as its portfolio. Investors can expect different levels of risks and returns from different types of portfolios. The portfolio is normally managed by a person called an investment advisor, who must be registered with the SEC.
A mutual fund is an open-end type of fund. This means that there is no limit on how many shares can be owned, and if there are more investors than there are available shares, the fund can create new shares. If an investor in the fund wants to sell shares, the fund itself can buy them back from the investor, unlike stocks where it is necessary to wait until a willing buyer comes along. The purchase price for the shares is based on the market rate at the time of the sale.
There are costs associated with owning mutual funds, which can vary significantly among funds. These costs typically include such things as operating costs and management fees. Another type of expense that can affect the return on mutual funds is the load, which is essentially the transaction fee that is paid to the broker. The load may be charged all once or spread out over a period of time, but either way it is a factor that must be considered. Also, the expenses continue whether or not the fund increases in value.
To determine the average rate of return on mutual funds, start with the total income. The income for mutual funds typically comes from stock dividends and capital gains on other investments. Next, subtract all expenses to determine the actual amount of gains realized. Subtract the investment capital from this number, and divide that total by the amount of the investment capital to get the return on investment for a specific period. Average several periods together to come up with the average rate of return on the investment. This number is typically reported as a percentage.
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