How do mutual fund companies make money
Investment funds - an overview of the most important things
The money deposited by many savers in a common pot is invested as profitably as possible by the fund managers.
In this way, the money can be distributed among different securities or objects. Since investment funds can usually be sold at any time, they represent an extremely liquid form of investment; so the money is always available. At most if stock exchanges remain closed for a long time, think of the last debt crisis in Greece, or if political unrest broke out, availability could be limited.
We will inform you about the different types of funds in the following text:
- Bond funds and bond index funds,
- Real estate mutual funds,
- Equity funds and equity index funds
We also give you an overview of basic considerations such as risk tolerance, costs and taxes. You will also find tips for the consultation.
Willingness to take risks
Thousands of different funds vie for the favor of large and small investors. There are different investment strategies behind the different funds. If you want to find the right package for you, you should find out about your personal needs and expectations be clear.
Which fund is suitable for whom depends primarily on the risk tolerance of the individual investor. If you expect above-average returns, you have to cut back on security, as the value of a risky fund can fluctuate significantly. If you prefer to be on the safe side, you should invest in funds that fluctuate less, but also have lower profit expectations.
Pension funds, for example, are relatively low-risk because they invest in fixed-income securities. On the other hand, country or sector funds with an investment focus on equities are highly speculative.
Bond funds, bond index funds
The funds invest primarily in Government or corporate debt securities. Their performance is particularly dependent on the Development of capital market rates dependent.
A reliable forecast of the interest rate development is impossible, however. When interest rates fall, the value of the bonds increases, the more so the longer the term of the bonds. When interest rates rise, the value falls. Bond funds that invest in bonds with very long residual terms are particularly susceptible to fluctuations in value. In addition, bonds carry the risk that the debtor can no longer meet his payment obligations. Larger losses are therefore possible - especially with bonds from debtors who are not certain that they will repay their debts. Finally, some funds still harbor currency risks when they invest in foreign currency bonds.
For reasons of cost savings, so-called in particular are recommended Bond index funds. Here, the composition of the portfolio is based on a bond index. The running costs are often only a fifth of the costs of pension funds, which are usually sold on a commission basis.
Real estate mutual funds
These funds invest primarily in leased commercial real estate. Future income therefore depends largely on whether and to what extent increases in value and rental income are achieved. If foreign properties are included in the portfolio, currency fluctuations also have an impact. In some cases, this risk can be significantly higher than with bond funds.
Open-ended real estate funds can be closed at any time if the market situation makes this step necessary. In this case, the return of the shares to the investment company can also be excluded for several months or even several years. In such cases it will usually be possible to sell the shares on the stock exchange, but then often with value discounts. In individual cases, however, this asset class can be an interesting addition to bond funds, as often only part of the income generated is taxable.
Equity funds, equity index funds
Since the value of the individual investment funds depends on how the stocks develop, greater fluctuations in value and corresponding loss opportunities must be expected. The more stocks from different industries (e.g. chemical industry, financial services, food industry) the investment fund contains, the lower the risk of large losses.
In addition to the distribution across different industries, a cross-border spread also lowers the risk of loss. It is therefore advisable to attach great importance to an international diversification across the most important investment regions and across the most important sectors. However, if you want to limit the associated currency risks, you can also choose the euro zone as an investment focus.
The ongoing annual costs are lowest for equity index funds (ETFs). In some cases, they are only a tenth of the costs of equity funds, which are usually sold on a commission basis.
Issue surcharges and management fees
Since the costs always reduce the achievable return, important cost factors such as front-end loads and management fees should be kept as low as possible.
An issue surcharge is a one-time fee for brokering the fund. Administration fees, on the other hand, are incurred annually. The management fee essentially includes the costs for managing the capital and a follow-up commission for the broker of the investment fund. Only the front-end load can be reduced through negotiation.
In the case of sales follow-up commissions, consumers can negotiate in individual cases to have these reimbursed at least partially annually.
With so-called Index funds (ETFs) generally do not incur any sales follow-up commissions or sales charges and the investment cost is lower. They are traded on the stock exchange. Here the customer only pays the usual bank transaction costs for purchase and sale.
Dividend and interest income
Mutual fund income is taxable income. Exchange rate gains are generally taxed at a flat rate of 25 percent plus solidarity surcharge and church tax.
When it comes to investments, the withholding tax is just one aspect among many. The consumer advice center advises against purchasing certain products for tax reasons alone.
Tips for the consultation
- Serious financial service providers do not call without being asked. Even advisors who only talk about their product offerings and do not ask about financial and life situation or investment goals are bad advisors.
- Write down your wishes and the recommendations of your advisor and inquire about the cost of the recommended products.
- If advisors claim that the expensive products they recommend are worth the money, then be suspicious. After all, many scientific studies show that the expensive actively managed mutual funds perform worse than the cheaper index funds in the long term. And the crystal ball, which shows the successful investments of the future, has not yet been invented.
- Therefore, note down all the sales arguments of the product broker or advisor and have your records countersigned, then you have better cards in the event of incorrect advice!
Further information on the topic
- If you take care of your finances yourself, you can save expensive commissions, fees and closing costs and choose the optimal investment for your own situation between opportunities and risks. Here are some tips to get you started.
- Here you will find further information on the subject of ETFs and our podcast "Investing in ETFs".
- Our return calculator can also provide you with assistance if you want to find out more about the risks and returns associated with investing in stocks. You can use it to try out how your decision on the ratio of (safe) fixed-term deposits and (risky) stocks affects the return on your investment.
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