What is a Mutual Fund?
A mutual fund can be defined as an entity that pools cash from a variety of investors for the sole purpose of investing the cash in shares, bonds, treasury bills etc (all together called a portfolio of investments). The profit derived from the diversified pool of investments are shared to investors in the funds annually or semi annually or as stipulated in the fund prospectus.
Who operates a mutual fund?
Mutual funds are operated by professional investment firms made up of people who are savvy with the money and capital market. Mutual Fund, as in Nigeria, can be operated by the investment arm of banks, stock brokerage firms, investment banks etc.
How is it different from a stockbroking firm?
A stockbroking firm is simply a company that on your behalf and instruction uses its licence to buy and/or sell shares on the stock market. With a stock brokerage firm, you give them an instruction to buy or sell shares of your choice. You also keep tabs on the performance of your stocks on a daily basis and monitor its performance independently. For a mutual fund, however, operators determine which Investment decisions to make rather than you giving instruction as to what shares should be bought for you or which you intend to sell. The shares you buy with the mutual fund is that of the fund and not that of the companies quoted on the stock exchange or indeed any quoted investments.
What do they invest in?
They invest in the money and capital market. Money Market instruments are Treasury Bills, Certificate of Deposits, Commercial Paper etc. In Nigeria, Banks and discount houses issue these instruments. Capital Markets are where Bonds, Stocks (Shares) are traded on a daily basis. Most mutual funds usually outline the type of investments they hope to make with money in their prospectus.
How much can I invest?
Mutual Funds typically have an investment band depending on the nature of the fund. Some can be as low as a minimum of N5,000, whilst some can be N100,000 and others N1,000,000.
What kind of dividends can I expect?
This depends on your risk appetite. For example, if you have N1,000.00 and think you can invest it in any business of your choice and get a profit of N20 per cent, then investing in a mutual fund that promises 14 per cent returns may not be a good idea for you. The return a mutual fund promises you should also be compared to returns one can get on risk free investments such as treasury bills etc. For example, if a Mutual Fund promises a minimum return of 12 per cent per annum and government pays interest of 14 per cent on Treasury Bills, then investing your self may just be a better idea. In general mutual funds will typically offer minimum returns that are benchmarked above inflation rates.
Do I pay tax on dividends received and when I liquidate my investment?
Yes, dividends from Mutual Funds in Nigeria are not tax-free. Withholding tax will be deducted before dividends are paid to you. However, you do not pay capital gains tax when you sell your shares in the fund. Losses from Mutual Fund investment cannot also be used to offset taxable profits.
What are open and closed mutual funds?
Open Ended Mutual Funds are funds that are open to continuous issuance of shares to investors. Operators of the fund continue to issue shares to the public to buy into the fund. Investors in the fund who do not wish to participate any further will simply resell their shares to the fund at the subsisting Net Asset Value. They can also reinvest in the funds whenever they want. Some Open Ended Funds also mandate you to keep your money with them for a specified period of time before you can sell or request for your money back. Open Funds are mostly unregulated and are not traded on the floor of the stock exchange. They are mostly floated by reputable organisations with a track record for performance
Closed Ended funds on the other hand are funds that have limited number of shares that are sold at the initial public offering (IPO). Once the IPO is over, the fund closes sale of its shares to the public. Being a regulated fund, the shares are traded on the stock exchange like the shares of any quoted company. So, if an investor decides he wants his money back he will simply put up his shares for sale. The share price of a closed fund is determined by both the value of the portfolio as well as the sentiments of investors towards demand and supply. This is unlike the Open Funds that are determined by simply dividing the value of the portfolio by the number of shares issues by the fund. The Securities and Exchange Commission as well as the NSE regulates closed ended funds. They play by the rules set by the regulatory authorities. Their share prices are also published daily on the pages of newspapers and can also be found on the Internet.
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Source: http://www.punchng.com/am-business/a-simple-guide-to-investing-in-mutual-fund/
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