How Does a Guaranteed-Interest Mutual Fund Work?

by Walter Johnson

A mutual fund is a type of investment in which many small investors pool their money in an investment company. This group of investors is seen as a single unit, and the pool of money is placed under a fund manager or administrator. This permits small investors to receive expert advice and investment opportunities that are normally only available to the very wealthy. A guaranteed-interest fund is one that has a regular cash flow backed by the investment company.

Guaranteed Interest

There are only two investment devices that guarantee cash flows. These are bonds and preferred stocks. Bonds are simply loans. Investors place their money in bonds because they are generally safe, and their investment earns a regular interest payment. Outside of the risk of default, bond investors are less at risk than stock investors, but returns are normally lower than the stock market. Preferred stock is a kind of stock that earns a regular and guaranteed dividend.

Investment Funds

A guaranteed-interest mutual fund is sometimes called a guaranteed investment account. These are normally funds that invest in a mixture of different bond types and preferred stock. You are guaranteed a cash flow in return. Normally, investors can choose the sort of bonds in which they invest, especially concerning the term rate. Some investors do not want their money tied up for long; others, especially retirees who want a stable income, are willing to invest in long-term bonds that are less stable but earn more money.

Long-Term Premiums

The elderly and those who want to use surplus funds to earn a stable income might be attracted to long-term bond commitments. These are significant because your money is tied up for a long period of time. There is more risk, too, because interest rate changes are harder to predict over the longer term. Therefore, the market rewards long-term investors with a “premium,” or a payment above the normal return rate to compensate for the amount of time their money is invested and the increased risk. In the case of a guaranteed fund, the risk is mitigated, because the mutual fund will underwrite the investment.

Profit

Guaranteed-interest mutual funds provide needed capital for both private and public sector institutions. Public sector debt such as Treasury Bills is almost risk free, but returns are generally low. Mutual funds offering guaranteed-interest investments want to diversify the kinds of bonds and stocks they invest in, so the risk of the higher-yield loans is compensated for by the stability of the lower-risk funds. If the fund itself is well run, there is no reason why this compensatory strategy could not earn a guaranteed income stream with minimal losses for the fund itself. The investors in the fund need to provide the amount of capital commensurate with their income demands, and, since these are guaranteed funds, that amount might be high. The mutual fund companies must gamble occasionally with higher-risk securities to earn a profit over and above what is guaranteed to investors.

About the Author

Walter Johnson has more than 20 years experience as a professional writer. After serving in the United Stated Marine Corps for several years, he received his doctorate in history from the University of Nebraska. Focused on economic topics, Johnson reads Russian and has published in journals such as “The Salisbury Review,” "The Constantian" and “The Social Justice Review."

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