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Mutual Funds: An Introduction and Brief History

Each of us does not have the experience or the time to build and manage an investment portfolio. There is an excellent alternative available: mutual funds.

A mutual fund is an investment intermediary through which people can pool their money and invest it according to a predetermined objective.

Each mutual fund investor gets a share of the fund proportional to the initial investment they make. The capital of the mutual fund is divided into shares or units and investors get a number of units proportional to their investment.

The investment objective of the mutual fund is always decided in advance. Mutual funds invest in bonds, stocks, money market instruments, real estate, commodities, or other investments, or often a combination of any of these.

Details about policies, objectives, charges, services, etc. of the funds are available in the fund’s prospectus and every investor should read the prospectus before investing in a mutual fund.

Investment decisions for the fund’s capital are made by a fund manager(s). The fund manager decides which securities will be purchased and in what amount.

The value of the units changes with the change in the aggregate value of the investments made by the mutual fund.

The value of each share or unit of the mutual fund is called NAV (Net Asset Value).

Different funds have different risk and reward profiles. A mutual fund that invests in stocks is a higher risk investment than a mutual fund that invests in government bonds. Stock values ​​can go down and cause an investor a loss, but money invested in bonds is safe (unless the government defaults, which is rare). At the same time, the increased risk in stocks also presents an opportunity for higher returns. Stocks can go up to any limit, but government bond yields are capped at the interest rate offered by the government.

History of Mutual Funds:

The first “money gathering” for investment was held in 1774. After the financial crisis of 1772-1773, a Dutch merchant, Adriaan van Ketwich, invited investors to band together to form an investment fund. The purpose of the trust was to reduce the risks involved in investing by providing diversification to small investors. The funds invested in several European countries such as Austria, Denmark and Spain. Investments were mainly in bonds and stocks made up a small portion. The trust was called Eendragt Maakt Magt, which meant “Unity creates strength”.

The fund had many features that attracted investors:

– It had a built-in lottery.

– There was an assured dividend of 4%, which was slightly lower than the prevailing average rates at the time. Therefore, the interest income exceeded the required payments and the difference was converted to a cash reserve.

– The cash reserve was used to retire some shares annually at a 10% premium, and therefore the remaining shares earned higher interest. Thus, the cash reserve continued to increase over time, further accelerating the redemption of shares.

– The trust would be dissolved after 25 years and the capital would be divided among the remaining investors.

However, a war with England caused many bonds to default. Due to declining investment income, stock redemption was discontinued in 1782, and later interest payments were also reduced. The fund became unattractive to investors and disappeared.

After evolving in Europe for a few years, the idea of ​​mutual funds came to the US in the late 19th century. In the year 1893, the first closed fund was formed. It was named “The Boston Personal Property Trust”.

The Alexander Fund in Philadelphia was the first step toward open funds. It was established in 1907 and had new editions every six months. Investors were allowed to make bailouts.

The first true open-end fund was the Massachusetts Investors’ Trust of Boston. Formed in the year 1924, it went public in 1928. 1928 also saw the rise of the first balanced fund: the Wellington Fund which invested in both stocks and bonds.

The concept of index funds was proposed by William Fouse and John McQuown of Wells Fargo Bank in 1971. Based on his concept, John Bogle launched the first retail index fund in 1976. It was called the First Index Investment Trust. It is now known as the Vanguard 500 Index Fund. It crossed $100 billion in assets in November 2000 and became the largest fund in the world.

Today mutual funds have come a long way. Nearly one in two households in the US invests in mutual funds. The popularity of mutual funds is also skyrocketing in developing economies like India. They have become the preferred investment avenue for many investors, who value the unique combination of diversification, low cost and simplicity that the funds offer.

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