Monetize Financial Academy

All the business entities need fund flow to finance their day to day operations. Therefore, for raising funds for the business there are two ways i.e. in the form of equity or through debt which represents the borrowed capital of the company. In equity, the entity approaches various individuals to sell its shares at a fixed price and when it is done for the first time it is referred to as IPO. While on the other hand, when the shares are offered for sale for the subsequent public contribution it is referred to as FPO.

Today, it is very important and beneficial to have a basic knowledge of IPO and FPO which is often used in the stock market. Also, let us discuss FPO vs. IPO below.
IPO Definition:
IPO is an abbreviation of Initial Public Offer. When a company is going for a process of getting listed on the stock exchange and publicly traded, IPO is the first public offering, it is the main source of the company in acquiring money from the general public to finance its projects and the company allots shares to the investors in return.
FPO Definition:
FPO is an abbreviation of a Follow-On Public Offer. The process of FPO starts after an IPO. FPO is a public issue of shares to investors at large by a publicly listed company. In FPO, the company goes for a further issue of shares to the general public with a view to diversifying its equity base. A prospectus is offered by the company.
There are two types of FPO:

• Dilutive offering
• Non-Dilutive offering

Now since we have learned above what is an IPO and what is FPO, now let us learn the difference between IPO and FPO and let’s compare IPO and FPO. For a company to run and grow, requires fund flow. Not just a start-up but even well-established companies require funds in order to continue with their ongoing process and to expand their business. Many times for the owner of the company, it is not possible to provide continuous supply of funds therefore, issuing share to the general public is the most convenient way for a company to raise capital.
Key Difference: IPO vs. FPO

• IPO is the first public issue of the shares of a private company that is going public whereas FPO is the second or subsequent public issue of the shares of an already listed public company.
• IPO is released with an intention to raise capital through public investment whereas FPO is offered with an aim to inflow subsequent public investment.
• An IPO is generally riskier than FPO as in IPO an individual investor does not know about what may happen with the company in the future. On the other hand in FPO, the investors are aware as the company is already listed on stock exchange. Therefore, the investors can study the past performance and make assumptions about the company’s future growth prospects.

When a company comes out with an initial public offer (IPO) it is called the primary market. The normal purpose of an IPO is to list the stock in the share market. Once the share gets listed it starts trading in the secondary market. Buying and selling shares is largely like buying and selling any other commodity.

How stock market works?
1. A company gets listed in the primary market through an IPO.
2. Shares get distriuted in the Secondary Market
3. The stocks issued can be traded by the investors in the secondary market.
4. Stock brokers and brokerage firms are entities registered with the stock exchange which offers you to buy particular share at said price
5. Your broker passes on your buy order to the exchange, which searches for a sell order for the same share.
6. The process takes T+2 days i.e. you will get your shares deposited in your demat account in two working days.

A share is a portion of the companyand when the company makes profits, you often receive a part of it. This is the idea behind dividends. Every year, companies distribute a small amount of profits to investors as dividends. This is the primary source of income for long-term shareholders – those who don’t sell the stock for years together.

An investor sells short when he anticipates that the price of a stock may fall from the existing price. So, the investor borrows a share and sells it. Once the share price dips, he will buy the same share at a lower price, and return it back, while pocketing a profit in the bargain. Simply put, you first sell at a high and then buy at a low. Short-selling helps traders profit from declining stock and index prices. Since this is usually conducted in anticipation of a stock movement, short-selling is considered a risky proposition.

Let us take an example. Suppose you expect shares of Infosys to fall tomorrow for whatever reason, you enter an order to sell shares of Infosys at the current market price. Once the share price falls adequately tomorrow, you buy at the lower rate. The difference in the sale and buying prices is your profit. However, if the share prices increase after you sold at a reduced price, then you end up with a loss.

Open interest is the total number of outstanding derivative contracts, such as options or futures that have not been settled for an asset. The total open interest does not count, and total every buy and sell contract. Instead, open interest provides a more accurate picture of the options trading activity, and whether money flows into the futures and options market are increasing or decreasing.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability. It is common for a company to report EPS that is adjusted for extraordinary items and potential share dilution. The higher a company’s EPS, the more profitable it is considered.

KEY TAKEAWAYS

• Earnings per share (EPS) is a company’s net profit divided by the number of common shares it has outstanding.
• EPS indicates how much money a company makes for each share of its stock and is a widely used metric for corporate profits.
• A higher EPS indicates more value because investors will pay more for a company with higher profits.
• EPS can be arrived at in several forms, such as excluding extraordinary items or discontinued operations, or on a diluted basis.

Formula and Calculation for EPS
The earnings per share value are calculated as the net income (also known as profits or earnings) divided by the available shares. A more refined calculation adjusts the numerator and denominator for shares that could be created through options, convertible debt, or warrants. The numerator of the equation is also more relevant if it is adjusted for continuing operations.

\text{Earnings per Share}=\frac{\text{Net Income }-\text{ Preferred Dividends}}{\text{End-of-Period Common Shares Outstanding}}Earnings per Share=End-of-Period Common Shares OutstandingNet Income − Preferred Dividends

To calculate a company’s EPS, the balance sheet and income statement are used to find the period-end number of common shares, dividends paid on preferred stock (if any), and the net income or earnings. It is more accurate to use a weighted average number of common shares over the reporting term because the number of shares can change over time.

Some stocks are more volatile than others. Too much volatility is not good for investors. To curb this volatility, SEBI has come up with the concept of circuit filters. The market regulator has specified the maximum limit the price of a stock can move on a given day. This is called a price trading band. If a stock breaches this limit, trading is halted in that stock for a while. There are three levels of limits. Each limit leads to trading halt for a progressively longer duration. If all three circuit filters are breached, then trading is halted for the rest of the day. NSE define circuit filters in 5 categories including 2%, 5%, 10%, 20% and no circuit filter.

Also, prices may not be same on the two exchanges – NSE and BSE. So, circuit filters can be different for shares on the two exchanges.

Stock prices constantly fluctuate. This is because the demand for the stock changes. As more stocks change hands, greater is the change in its share price. This is called stock volatility. Even the amount of volatility in the market changes on a daily basis. To measure this volatility, the National Stock Exchange introduced the VIX India index, also called the fear gauge. VIX is often used as an indicator of stock price trends. This is because, VIX rises when there is more fear and uncertainty in the market.

This means, investors perceive an increase in risk. This usually follows a fall in the market.

Premarket trading is a trading that occurs on exchanges before the regular market trading hours begin. The pre market stock trading takes place between the hours of 8:00 AM and 9:30 AM. The volumes traded in premarket sessions are usually much lower as compared to regular trading hours. Due to very few participants active before the market hours i.e. 9:30 AM, investors find it difficult to execute transactions.

In premarket sessions, investors have less liquidity i.e. converting stocks into cash therefore, the prices may not adjust as quickly as they do in the regular market session.

Premarket trading background

Pre-market trades are executed on computer-based systems including alternative trading systems and electronic communications networks. Premarket trading is used by traders for various reasons like:

• To see where the market and individual securities are headed when regular trading starts.
• To try to get ahead of market reactions to breaking news like overseas events, political instability, and other factors that can affect markets or individual securities.
• If a corporation releases an earnings announcement after the market closes and it could cause the stock to rise or fall the next trading day, then the premarket trader can attempt to buy or sell early before the regular market session.

Different companies issue varied amounts of shares when they get listed. The value of one share also differs from that of another company’s stock. Market capitalization smoothens out these differences. It is the market stock price multiplied by the total number of shares held by the public. It, thus, reflects the total market value of a stock taking into consideration both the size and the price of the stock. For example, if a stock is priced at Rs. 50 per share, and there are 1,00,000 shares in the hands of public investors, then its market capitalization stands at Rs. 50,00,000.

Market capitalization matters when stacking stocks into different indices. It also decides the weightage of a stock in the index. This means, bigger the company’s market value, the more its price fluctuations affect the value of the index.

The pre open market sessions are from 9:00 AM to 9:15 AM for both the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). Pre open market is basically the period of trading activity which takes place just before the regular stock market session.

Trading in extended sessions happens electronically i.e. through Electronic Communication Network (ECNs). When buy order is placed at a predetermined rate, ECNs keeps a track and the moment there is any matching sell order it acts as a matchmaker bringing them close to each other hence, completely makes the broker null and void. In premarket trading sessions, the liquidity levels are quite tight and the trade is rather volatile.

Before proceeding, let us learn a few basic terms i.e. type of orders that are placed in market:

• Market Orders: When the price of the order is not specified during buying or selling, such orders are executed as per the availing market rates.
• Limit Orders: When the price and quantity of orders are specified for buying and selling, these are executed once the matching orders are found.

The 15-minute session consists of mainly 3 slots:

• 9:00 AM – 9:08 AM: It is known as the order collection period. During this period, the orders can be modified or canceled.
• 9:08 AM -9:12 AM: It is known as order matching period and trade confirmation period. In this period placed orders are confirmed based on the price identification method referred to as “Equilibrium price determination” or “Call auction”. During this period modification or cancellation of placed order cannot be done.
• 9:12 AM – 9:15 AM: It is known as a buffer period and it facilitates the transition from pre open market to normal market session.

Shares/ Equity:
Equities or stocks or shares give you ownership of a company. You can buy or sell shares through a broker.
Mutual funds:
Here, the money is pooled from many investors and then invested in various financial instruments. Investors are referred to as unit holders. Profit generated is distributed to unit holders in proportion to the units held by them.
Bonds:
These are fixed income instruments also known as debt instruments by which government or a company borrows money from investors at an agreed interest rate for a specific tenure. These are less risky when compared to shares.
Derivatives:
A derivative is a financial contract whose value is derived from an underlying asset. It can be used to mitigate a number of risks. Derivatives include forward, futures, options and swaps.

Fundamental analysis is about understanding the business of the company, its growth prospects, its profitability, its debt etc.Technical analysis focuses more on charts and patterns and tries to find out past patterns to apply for the future. Fundamentals are used more by investors while technicals are used more by traders.

Before entering in any trade/ Investment

• Its always better to do your own research before investing.
• Its not wise to take decision based on rumors.
• Monitor your investments regularly so that you can eliminate the loss making stocks.
• Patience is very essential for any investor.
• Always be updated with share market news.
• Always use uniform trading strategy
• Always know your stop loss or Risk associated with your trade/Investment
• Do not overtrade
• Treat this as business rather than a gambling activity

When you buy a share, you can be a common shareholder or preferred shareholder on the basis of ownership.
As a common shareholder, you are permitted to vote in shareholder meetings and you are eligible to receive dividends. If the company where you have invested goes bankrupt, you will receive the share of proceeds of liquidation only after all creditors and preferred shareholders have been paid.
As a preferred shareholder, you may not have voting rights. But you will get dividends before common shareholder receives it.
On the basis of market capitalization, you can invest in large cap, mid cap and small cap stocks. Market capitalization = share price*number of shares outstanding
Outstanding shares are the shares that can be bought and sold in public markets. I will explain this with an example. Say a company A has 100 outstanding shares and the share price is Rs. 20, then market capitalization of the company will be 20*100=Rs. 2000

Large cap stocks:
These companies are well established and have a strong presence in the market. Companies like TCS, Infosys and Wipro fall under this category. Investing in these companies are less risky.
Mid cap stocks:
These companies have the potential to grow big and are relatively riskier compared to the large cap companies.
Small cap stocks:
Start ups fall under this category and are highly risky compared to the above two. On the upside, they can become a runaway success overnight.
The next essential aspect you should know is IPO (Initial Public Offer). A company raises money from public through IPO. It sells its shares so as to bring in capital for its future development. Your yield is high when you invest in a share due to the power of compounding. In simple terms, the price of share you hold today may be Rs. 100, it can double or triple if you hold the share for a long time.

Thousands of companies list their shares on the Indian share markets. From these, a few similar stocks are grouped together to form an index. The classification may be on the basis of company size, industry, market capitalization, or other categories. The BSE Sensex includes 30 stocks and the NSE comprises 50 stocks. Others include sector indices like the Bankex, market cap indices like the BSE Midcap or the BSE Small cap, and others.

Fundamental analysis is about understanding the business of the company, its growth prospects, its profitability, its debt etc.Technical analysis focuses more on charts and patterns and tries to find out past patterns to apply for the future. Fundamentals are used more by investors while technicals are used more by traders.

Before entering in any trade/ Investment

• Its always better to do your own research before investing.
• Its not wise to take decision based on rumors.
• Monitor your investments regularly so that you can eliminate the loss making stocks.
• Patience is very essential for any investor.
• Always be updated with share market news.
• Always use uniform trading strategy
• Always know your stop loss or Risk associated with your trade/Investment
• Do not overtrade
• Treat this as business rather than a gambling activity

Fundamental analysis (FA) is a method of measuring a security’s intrinsic value by examining related economic and financial factors. Fundamental analysts study anything that can affect the security’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management.
The end goal is to arrive at a number that an investor can compare with a security’s current price in order to see whether the security is undervalued or overvalued.
This method of stock analysis is considered to be in contrast to technical analysis, which forecasts the direction of prices through an analysis of historical market data such as price and volume.

KEY TAKEAWAYS

• Fundamental analysis is a method of determining a stock’s real or “fair market” value.
• Fundamental analysts search for stocks that are currently trading at prices that are higher or lower than their real value.
• If the fair market value is higher than the market price, the stock is deemed to be undervalued and a buy recommendation is given.
• In contrast, technical analysts ignore the fundamentals in favor of studying the historical price trends of the stock.

Understanding Fundamental Analysis
All stock analysis tries to determine whether a security is correctly valued within the broader market. Fundamental analysis is usually done from a macro to micro perspective in order to identify securities that are not correctly priced by the market.

Analysts typically study, in order, the overall state of the economy and then the strength of the specific industry before concentrating on individual company performance to arrive at a fair market value for the stock.
Fundamental analysis uses public data to evaluate the value of a stock or any other type of security. For example, an investor can perform fundamental analysis on a bond’s value by looking at economic factors such as interest rates and the overall state of the economy, then studying information about the bond issuer, such as potential changes in its credit rating.

For stocks, fundamental analysis uses revenues, earnings, future growth, return on equity,profit margins, and other data to determine a company’s underlying value and potential for future growth. All of this data is available in a company’s financial statements (more on that below).

Fundamental analysis is used most often for stocks, but it is useful for evaluating any security, from a bond to a derivative. If you consider the fundamentals, from the broader economy to the company details, you are doing fundamental analysis.

Investing and Fundamental Analysis

An analyst uses works to create a model for determining the estimated value of a company’s share price based on publicly available data. This value is only an estimate, the analyst’s educated opinion, of what the company’s share price should be worth compared to the currently trading market price. Some analysts may refer to their estimated price as the company’s intrinsic value.

If an analyst calculates that the stock’s value should be significantly higher than the stock’s current market price, they may publish a buy or overweight rating for the stock. This acts as a recommendation to investors who follow that analyst. If the analyst calculates a lower intrinsic value than the current market price, the stock is considered overvalued and a sell or underweight recommendation is issued.

Investors who follow these recommendations will expect that they can buy stocks with favorable recommendations because such stocks should have a higher probability of rising over time. Likewise stocks with unfavorable ratings are expected to have a higher probability of falling in price. Such stocks are candidates for being removed from existing portfolios or added as “short positions.

This method of stock analysis is considered to be the opposite of technical analysis, which forecasts the direction of prices through an analysis of historical market data such as price and volume.

Quantitative and Qualitative Fundamental Analysis

The problem with defining the word fundamentals is that it can cover anything related to the economic well-being of a company. They obviously include numbers like revenue and profit, but they can also include anything from a company’s market share to the quality of its management.

The various fundamental factors can be grouped into two categories: quantitative and qualitative. The financial meaning of these terms isn’t much different from their standard definitions. Here is how a dictionary defines the terms:

• Quantitative – capable of being measured or expressed in numerical terms.
• Qualitative – related to or based on the quality or character of something, often as opposed to its size or quantity.

In this context, quantitative fundamentals are hard numbers. They are the measurable characteristics of a business. That’s why the biggest source of quantitative data is financial statements. Revenue, profit, assets, and more can be measured with great precision.

The qualitative fundamentals are less tangible. They might include the quality of a company’s key executives, its brand-name recognition, patents, and proprietary technology.

Neither qualitative nor quantitative analysis is inherently better. Many analysts consider them together.

Qualitative Fundamentals to Consider
There are four key fundamentals that analysts always consider when regarding a company. All are qualitative rather than quantitative. They include:

• The business model: What exactly does the company do? This isn’t as straightforward as it seems. If a company’s business model is based on selling fast-food chicken, is it making its money that way? Or is it just coasting on royalty and franchise fees?
• Competitive advantage: A company’s long-term success is driven largely by its ability to maintain a competitive advantage—and keep it. Powerful competitive advantages, such as Coca Cola’s brand name and Microsoft’s domination of the personal computer operating system, create a moat around a business allowing it to keep competitors at bay and enjoy growth and profits. When a company can achieve a competitive advantage, its shareholders can be well rewarded for decades.
• Management: Some believe that management is the most important criterion for investing in a company. It makes sense: Even the best business model is doomed if the leaders of the company fail to properly execute the plan. While it’s hard for retail investors to meet and truly evaluate managers, you can look at the corporate website and check the resumes of the top brass and the board members. How well did they perform in prior jobs? Have they been unloading a lot of their stock shares lately?
• Corporate Governance: Corporate governance describes the policies in place within an organization denoting the relationships and responsibilities between management, directors and stakeholders. These policies are defined and determined in the company charter and its bylaws, along with corporate laws and regulations. You want to do business with a company that is run ethically, fairly, transparently, and efficiently. Particularly note whether management respects shareholder rights and shareholder interests. Make sure their communications to shareholders are transparent, clear and understandable. If you don’t get it, it’s probably because they don’t want you to.

It’s also important to consider a company’s industry: customer base, market share among firms, industry-wide growth, competition, regulation, and business cycles. Learning about how the industry works will give an investor a deeper understanding of a company’s financial health.

Financial Statements: Quantitative Fundamentals to Consider

Financial statements are the medium by which a company discloses information concerning its financial performance. Followers of fundamental analysis use quantitative information gleaned from financial statements to make investment decisions. The three most important financial statements are income statements, balance sheets, and cash flow statements.

The Balance Sheet

The balance sheet represents a record of a company’s assets, liabilities and equity at a particular point in time. The balance sheet is named by the fact that a business’s financial structure balances in the following manner:

Assets = Liabilities + Shareholders’ Equity

Assets represent the resources that the business owns or controls at a given point in time. This includes items such as cash, inventory, machinery and buildings. The other side of the equation represents the total value of the financing the company has used to acquire those assets. Financing comes as a result of liabilities or equity. Liabilities represent debt (which of course must be paid back), while equity represents the total value of money that the owners have contributed to the business – including retained earnings, which is the profit made in previous years.

The Income Statement

While the balance sheet takes a snapshot approach in examining a business, the income statement measures a company’s performance over a specific time frame. Technically, you could have a balance sheet for a month or even a day, but you’ll only see public companies report quarterly and annually.

The income statement presents information about revenues, expenses and profit that was generated as a result of the business’ operations for that period.

Statement of Cash Flows

The statement of cash flows represents a record of a business’ cash inflows and outflows over a period of time. Typically, a statement of cash flows focuses on the following cash-related activities:

• Cash from investing (CFI): Cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment or long-term assets
• Cash from financing (CFF): Cash paid or received from the issuing and borrowing of funds
• Operating Cash Flow (OCF): Cash generated from day-to-day business operations

The cash flow statement is important because it’s very difficult for a business to manipulate its cash situation. There is plenty that aggressive accountants can do to manipulate earnings, but it’s tough to fake cash in the bank. For this reason, some investors use the cash flow statement as a more conservative measure of a company’s performance.

Fundamental analysis relies on the use of financial ratios drawn from data on corporate financial statements to make inferences about a company’s value and prospects.

The Concept of Intrinsic Value

One of the primary assumptions of fundamental analysis is that the currently price from the stock market often does not fully reflect a value of the company supported by the publicly available data. A second assumption is that the value reflected from the company’s fundamental data is more likely to be closer to a true value of the stock.

Analysts often refer to this hypothetical true value as the intrinsic value. However, it should be noted that this usage of the phrase intrinsic value means something different in stock valuation than what it means in other contexts such as options trading. Option pricing uses a standard calculation for intrinsic value, however analysts use a various complex models to arrive at their intrinsic value for a stock. There is not a single, generally accepted formula for arriving at the intrinsic value of a stock.

For example, say that a company’s stock was trading at $20, and after extensive research on the company, an analyst determines that it ought to be worth $24. Another analyst does equal research but determines that it ought to be worth $26. Many investors will consider the average of such estimates and assume that intrinsic value of the stock may be near $25. Often investors consider these estimates highly relevant information because they want to buy stocks that are trading at prices significantly below these intrinsic values.

This leads to a third major assumption of fundamental analysis: In the long run, the stock market will reflect the fundamentals. The problem is, nobody knows how long “the long run” really is. It could be days or years.

This is what fundamental analysis is all about. By focusing on a particular business, an investor can estimate the intrinsic value of a firm and find opportunities to buy at a discount. The investment will pay off when the market catches up to the fundamentals.

One of the most famous and successful fundamental analysts is the so-called “Oracle of Omaha,” Warren Buffett, who champions the technique in picking stocks.

Criticisms of Fundamental Analysis
The biggest criticisms of fundamental analysis come primarily from two groups: proponents of technical analysis and believers of the efficient market hypothesis.

Technical Analysis
Technical analysis is the other primary form of security analysis. Put simply, technical analysts base their investments (or, more precisely, their trades) solely on the price and volume movements of stocks. Using charts and other tools, they trade on momentum and ignore the fundamentals.

One of the basic tenets of technical analysis is that the market discounts everything. All news about a company is already priced into the stock. Therefore, the stock’s price movements give more insight than the underlying fundamentals of the business itself.

The Efficient Market Hypothesis

Followers of the efficient market hypothesis (EMH), however, are usually in disagreement with both fundamental and technical analysts.
The efficient market hypothesis contends that it is essentially impossible to beat the market through either fundamental or technical analysis. Since the market efficiently prices all stocks on an ongoing basis, any opportunities for excess returns are almost immediately whittled away by the market’s many participants, making it impossible for anyone to meaningfully outperform the market over the long term.

Examples of Fundamental Analysis
Take the Coca-Cola Company, for example. When examining its stock, an analyst must look at the stock’s annual dividend payout, earnings per share, P/E ratio, and many other quantitative factors. However, no analysis of Coca-Cola is complete without taking into account its brand recognition. Anybody can start a company that sells sugar and water, but few companies are known to billions of people. It’s tough to put a finger on exactly what the Coke brand is worth, but you can be sure that it’s an essential ingredient contributing to the company’s ongoing success.

Even the market as a whole can be evaluated using fundamental analysis. For example, analysts looked at fundamental indicators of the S&P 500 from July 4 to July 8, 2016. During this time, the S&P rose to 2129.90 after the release of a positive jobs’ report in the United States. In fact, the market just missed a new record high, coming in just under the May 2015 high of 2132.80. The economic surprise of an additional 287,000 jobs for the month of June specifically increased the value of the stock market on July 8, 2016.

However, there are differing views on the market’s true value. Some analysts believe the economy is heading for a bear market, while other analysts believe it will continue as a bull market.

An exchange-traded fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index, although they can invest in any number of industry sectors or use various strategies. ETFs are in many ways similar to mutual funds; however, they are listed on exchanges and ETF shares trade throughout the day just like ordinary stock.

Some well-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index. ETFs can contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types. An exchange-traded fund is a marketable security, meaning it has an associated price that allows it to be easily bought and sold.

KEY TAKEAWAYS

• An exchange-traded fund (ETF) is a basket of securities that trade on an exchange, just like a stock.
• ETF share prices fluctuate all day as the ETF is bought and sold; this is different from mutual funds that only trade once a day after the market closes.
• ETFs can contain all types of investments including stocks, commodities, or bonds; some offer U.S. only holdings, while others are international.
• ETFs offer low expense ratios and fewer broker commissions than buying the stocks individually.

An ETF is called an exchange-traded fund since it’s traded on an exchange just like stocks. The price of an ETF’s shares will change throughout the trading day as the shares are bought and sold on the market. This is unlike mutual funds, which are not traded on an exchange, and trade only once per day after the markets close.
An ETF is a type of fund that holds multiple underlying assets, rather than only one like a stock. Because there are multiple assets within an ETF, they can be a popular choice for diversification.
An ETF can own hundreds or thousands of stocks across various industries, or it could be isolated to one particular industry or sector. Some funds focus on only U.S. offerings, while others have a global outlook. For example, banking-focused ETFs would contain stocks of various banks across the industry.

Types of ETFs
There are various types of ETFs available to investors that can be used for income generation, speculation, price increases, and to hedge or partly offset risk in an investor’s portfolio. Below are several examples of the types of ETFs.

• Bond ETFs might include government bonds, corporate bonds, and state and local bonds—called municipal bonds.
• Industry ETFs track a particular industry such as technology, banking, or the oil and gas sector.
• Commodity ETFs invest in commodities including crude oil or gold.
• Currency ETFs invest in foreign currencies such as the Euro or Canadian dollar.
• Inverse ETFs attempt to earn gains from stock declines by shorting stocks. Shorting is selling a stock, expecting a decline in value, and repurchasing it at a lower price.

Investors should be aware that many inverse ETFs are Exchange Traded Notes (ETNs) and not true ETFs. An ETN is a bond but trades like a stock and is backed by an issuer like a bank. Be sure to check with your broker to determine if an ETN is a right fit for your portfolio.

In the U.S., most ETFs are set up as open-ended funds and are subject to the Investment Company Act of 1940 except where subsequent rules have modified their regulatory requirements. Open-end funds do not limit the number of investors involved in the product.

How to Buy and Sell ETFs

ETFs trade through online brokers and traditional broker-dealers. You can view some of the top brokers in the industry for ETFs with Investopedia’s list of the best brokers for ETFs. An alternative to standard brokers are robo-advisors like Betterment and Wealthfront who make use of ETFs in their investment products.

Real World Examples of ETFs
Below are examples of popular ETFs on the market today. Some ETFs track an index of stocks creating a broad portfolio while others target specific industries.

• SPDR S&P 500 (SPY): The oldest surviving and most widely known ETF tracks the S&P 500 Index
• iShares Russell 2000 (IWM): Tracks the Russell 2000 small-cap index
• Invesco QQQ (QQQ): Indexes the Nasdaq 100, which typically contains technology stocks
• SPDR Dow Jones Industrial Average (DIA): Represents the 30 stocks of the Dow Jones Industrial Average
• Sector ETFs: Track individual industries such as oil (OIH), energy (XLE), financial services (XLF), REITs (IYR), Biotech (BBH)
• Commodity ETFs: Represent commodity markets including crude oil (USO) and natural gas (UNG)
• Physically-Backed ETFs: The SPDR Gold Shares (GLD) and iShares Silver Trust (SLV) hold physical gold and silver bullion in the fund

Advantages and Disadvantages of ETFs
ETFs provide lower average costs since it would be expensive for an investor to buy all the stocks held in an ETF portfolio individually. Investors only need to execute one transaction to buy and one transaction to sell, which leads to fewer broker commissions since there are only a few trades being done by investors. Brokers typically charge a commission for each trade. Some brokers even offer no-commission trading on certain low-cost ETFs reducing costs for investors even further.

An ETF’s expense ratio is the cost to operate and manage the fund. ETFs typically have low expenses since they track an index. For example, if an ETF tracks the S&P 500 index, it might contain all 500 stocks from the S&P making it a passively-managed fund and less time-intensive. However, not all ETFs track an index in a passive manner.

A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a vast number of securities, and performance is usually tracked as the change in the total market cap of the fund—derived by the aggregating performance of the underlying investments.

KEY TAKEAWAYS

• A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other securities.
• Mutual funds give small or individual investors access to diversified, professionally managed portfolios at a low price.
• Mutual funds are divided into several kinds of categories, representing the kinds of securities they invest in, their investment objectives, and the type of returns they seek.
• Mutual funds charge annual fees (called expense ratios) and, in some cases, commissions, which can affect their overall returns.
• The overwhelming majority of money in employer-sponsored retirement plans goes into mutual funds.

Understanding Mutual Funds

Mutual funds pool money from the investing public and use that money to buy other securities, usually stocks and bonds. The value of the mutual fund company depends on the performance of the securities it decides to buy. So, when you buy a unit or share of a mutual fund, you are buying the performance of its portfolio or, more precisely, a part of the portfolio’s value. Investing in a share of a mutual fund is different from investing in shares of stock. Unlike stock, mutual fund shares do not give its holders any voting rights. A share of a mutual fund represents investments in many different stocks (or other securities) instead of just one holding.

That’s why the price of a mutual fund share is referred to as the net asset value (NAV) per share, sometimes expressed as NAVPS. A fund’s NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding. Outstanding shares are those held by all shareholders, institutional investors, and company officers or insiders. Mutual fund shares can typically be purchased or redeemed as needed at the fund’s current NAV, which—unlike a stock price—doesn’t fluctuate during market hours, but it is settled at the end of each trading day.

The average mutual fund holds hundreds of different securities, which means mutual fund shareholders gain important diversification at a low price. Consider an investor who buys only Google stock before the company has a bad quarter. He stands to lose a great deal of value because all of his dollars are tied to one company. On the other hand, a different investor may buy shares of a mutual fund that happens to own some Google stock. When Google has a bad quarter, she loses significantly less because Google is just a small part of the fund’s portfolio.

How Mutual Funds Work

A mutual fund is both an investment and an actual company. This dual nature may seem strange, but it is no different from how a share of AAPL is a representation of Apple Inc. When an investor buys Apple stock, he is buying partial ownership of the company and its assets. Similarly, a mutual fund investor is buying partial ownership of the mutual fund company and its assets. The difference is that Apple is in the business of making innovative devices and tablets, while a mutual fund company is in the business of making investments.

Investors typically earn a return from a mutual fund in three ways:

1. Income is earned from dividends on stocks and interest on bonds held in the fund’s portfolio. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution. Funds often give investors a choice either to receive a check for distributions or to reinvest the earnings and get more shares.
2. If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
3. If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit in the market.

If a mutual fund is construed as a virtual company, its CEO is the fund manager, sometimes called its investment adviser. The fund manager is hired by a board of directors and is legally obligated to work in the best interest of mutual fund shareholders. Most fund managers are also owners of the fund. There are very few other employees in a mutual fund company. The investment adviser or fund manager may employ some analysts to help pick investments or perform market research. A fund accountant is kept on staff to calculate the fund’s NAV, the daily value of the portfolio that determines if share prices go up or down. Mutual funds need to have a compliance officer or two, and probably an attorney, to keep up with government regulations.

Most mutual funds are part of a much larger investment company; the biggest have hundreds of separate mutual funds. Some of these fund companies are names familiar to the general public, such as Fidelity Investments, The Vanguard Group, T. Rowe Price, and Oppenheimer Funds.

Types of Mutual Funds

Mutual funds are divided into several kinds of categories, representing the kinds of securities they have targeted for their portfolios and the type of returns they seek. There is a fund for nearly every type of investor or investment approach. Other common types of mutual funds include money market funds, sector funds, alternative funds, smart-beta funds, target-date funds, and even funds-of-funds, or mutual funds that buy shares of other mutual funds.

Equity Funds

The largest category is that of equity or stock funds. As the name implies, this sort of fund invests principally in stocks. Within this group are various subcategories. Some equity funds are named for the size of the companies they invest in: small-, mid-, or large-cap. Others are named by their investment approach: aggressive growth, income-oriented, value, and others. Equity funds are also categorized by whether they invest in domestic (U.S.) stocks or foreign equities. There are so many different types of equity funds because there are many different types of equities. A great way to understand the universe of equity funds is to use a style box, an example of which is below.

The idea here is to classify funds based on both the size of the companies invested in (their market caps) and the growth prospects of the invested stocks. The term value fund refers to a style of investing that looks for high-quality, low-growth companies that are out of favor with the market. These companies are characterized by low price-to-earnings (P/E) ratios, low price-to-book (P/B) ratios, and high dividend yields. Conversely, spectrums are growth funds, which look to companies that have had (and are expected to have) strong growth in earnings, sales, and cash flows. These companies typically have high P/E ratios and do not pay dividends. A compromise between strict value and growth investment is a “blend,” which simply refers to companies that are neither value nor growth stocks and are classified as being somewhere in the middle.

The other dimension of the style box has to do with the size of the companies that a mutual fund invests in. Large-cap companies have high market capitalizations, with values over $5 billion. Market cap is derived by multiplying the share price by the number of shares outstanding. Large-cap stocks are typically blue chip firms that are often recognizable by name. Small-cap stocks refer to those stocks with a market cap ranging from $200 million to $2 billion. These smaller companies tend to be newer, riskier investments. Mid-cap stocks fill in the gap between small- and large-cap.

A mutual fund may blend its strategy between investment style and company size. For example, a large-cap value fund would look to large-cap companies that are in strong financial shape but have recently seen their share prices fall and would be placed in the upper left quadrant of the style box (large and value). The opposite of this would be a fund that invests in startup technology companies with excellent growth prospects: small-cap growth. Such a mutual fund would reside in the bottom right quadrant (small and growth).

Fixed-Income Funds

Another big group is the fixed income category. A fixed-income mutual fund focuses on investments that pay a set rate of return, such as government bonds, corporate bonds, or other debt instruments. The idea is that the fund portfolio generates interest income, which it then passes on to the shareholders.
Sometimes referred to as bond funds, these funds are often actively managed and seek to buy relatively undervalued bonds in order to sell them at a profit. These mutual funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren’t without risk. Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high-yield junk bonds is much riskier than a fund that invests in government securities. Furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up, the value of the fund goes down.

Index Funds

Another group, which has become extremely popular in the last few years, falls under the moniker “index funds.” Their investment strategy is based on the belief that it is very hard, and often expensive, to try to beat the market consistently. So, the index fund manager buys stocks that correspond with a major market index such as the S&P 500 or the Dow Jones Industrial Average (DJIA). This strategy requires less research from analysts and advisors, so there
are fewer expenses to eat up returns before they are passed on to shareholders. These funds are often designed with cost-sensitive investors in mind.

Balanced Funds

Balanced funds invest in a hybrid of asset classes, whether stocks, bonds, money market instruments, or alternative investments. The objective is to reduce the risk of exposure across asset classes.This kind of fund is also known as an asset allocation fund. There are two variations of such funds designed to cater to the investors objectives.

Some funds are defined with a specific allocation strategy that is fixed, so the investor can have a predictable exposure to various asset classes. Other funds follow a strategy for dynamic allocation percentages to meet various investor objectives. This may include responding to market conditions, business cycle changes, or the changing phases of the investor’s own life.
While the objectives are similar to those of a balanced fund, dynamic allocation funds do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given freedom to switch the ratio of asset classes as needed to maintain the integrity of the fund’s stated strategy.

Money Market Funds

The money market consists of safe (risk-free), short-term debt instruments, mostly government Treasury bills. This is a safe place to park your money. You won’t get substantial returns, but you won’t have to worry about losing your principal. A typical return is a little more than the amount you would earn in a regular checking or savings account and a little less than the average certificate of deposit (CD). While money market funds invest in ultra-safe assets, during the 2008 financial crisis, some money market funds did experience losses after the share price of these funds, typically pegged at $1, fell below that level and broke the buck.

Income Funds

Income funds are named for their purpose: to provide current income on a steady basis. These funds invest primarily in government and high-quality corporate debt, holding these bonds until maturity in order to provide interest streams. While fund holdings may appreciate in value, the primary objective of these funds is to provide steady cash flow to investors. As such, the audience for these funds consists of conservative investors and retirees. Because they produce regular income, tax-conscious investors may want to avoid these funds.

International/Global Funds

An international fund (or foreign fund) invests only in assets located outside your home country. Global funds, meanwhile, can invest anywhere around the world, including within your home country. It’s tough to classify these funds as either riskier or safer than domestic investments, but they have tended to be more volatile and have unique country and political risks. On the flip side, they can, as part of a well-balanced portfolio, actually reduce risk by increasing diversification, since the returns in foreign countries may be uncorrelated with returns at home. Although the world’s economies are becoming more interrelated, it is still likely that another economy somewhere is outperforming the economy of your home country.

Specialty Funds

This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don’t necessarily belong to the more rigid categories we’ve described so far. These types of mutual funds forgo broad diversification to concentrate on a certain segment of the economy or a targeted strategy. Sector funds are targeted strategy funds aimed at specific sectors of the economy, such as financial, technology, health, and so on. Sector funds can, therefore, be extremely volatile since the stocks in a given sector tend to be highly correlated with each other. There is a greater possibility for large gains, but a sector may also collapse (for example, the financial sector in 2008 and 2009).

Regional funds make it easier to focus on a specific geographic area of the world. This can mean focusing on a broader region (say Latin America) or an individual country (for example, only Brazil). An advantage of these funds is that they make it easier to buy stock in foreign countries, which can otherwise be difficult and expensive. Just like for sector funds, you have to accept the high risk of loss, which occurs if the region goes into a bad recession.
Socially-responsible funds (or ethical funds) invest only in companies that meet the criteria of certain guidelines or beliefs. For example, some socially-responsible funds do not invest in “sin” industries such as tobacco, alcoholic beverages, weapons, or nuclear power. The idea is to get competitive performance while still maintaining a healthy conscience. Other such funds invest primarily in green technology, such as solar and wind power or recycling.

Exchange Traded Funds (ETFs)

A twist on the mutual fund is the exchange traded fund (ETF). These ever more popular investment vehicles pool investments and employ strategies consistent with mutual funds, but they are structured as investment trusts that are traded on stock exchanges and have the added benefits of the features of stocks. For example, ETFs can be bought and sold at any point throughout the trading day. ETFs can also be sold short or purchased on margin. ETFs also typically carry lower fees than the equivalent mutual fund. Many ETFs also benefit from active options markets, where investors can hedge or leverage their positions. ETFs also enjoy tax advantages from mutual funds. The popularity of ETFs speaks to their versatility and convenience.

Mutual Fund Fees
A mutual fund will classify expenses into either annual operating fees or shareholder fees. Annual fund operating fees are an annual percentage of the funds under management, usually ranging from 1–3%. Annual operating fees are collectively known as the expense ratio. A fund’s expense ratio is the summation of the advisory or management fee and its administrative costs.
Shareholder fees, which come in the form of sales charges, commissions, and redemption fees, are paid directly by investors when purchasing or selling the funds. Sales charges or commissions are known as “the load” of a mutual fund. When a mutual fund has a front-end load, fees are assessed when shares are purchased. For a back-end load, mutual fund fees are assessed when an investor sells his shares.

Sometimes, however, an investment company offers a no-load mutual fund, which doesn’t carry any commission or sales charge. These funds are distributed directly by an investment company, rather than through a secondary party.
Some funds also charge fees and penalties for early withdrawals or selling the holding before a specific time has elapsed. Also, the rise of exchange-traded funds, which have much lower fees thanks to their passive management structure, have been giving mutual funds considerable competition for investors’ dollars. Articles from financial media outlets regarding how fund expense ratios and loads can eat into rates of return have also stirred negative feelings about mutual funds.

Classes of Mutual Fund Shares

Mutual fund shares come in several classes. Their differences reflect the number and size of fees associated with them.

Currently, most individual investors purchase mutual funds with A shares through a broker. This purchase includes a front-end load of up to 5% or more, plus management fees and ongoing fees for distributions, also known as 12b-1 fees. To top it off, loads on A shares vary quite a bit, which can create a conflict of interest. Financial advisors selling these products may encourage clients to buy higher-load offerings to bring in bigger commissions for themselves. With front-end funds, the investor pays these expenses as they buy into the fund.
To remedy these problems and meet fiduciary-rule standards, investment companies have started designating new share classes, including “level load” C shares, which generally don’t have a front-end load but carry a 1% 12b-1 annual distribution fee.

Funds that charge management and other fees when an investor sell their holdings are classified as Class B shares.

A New Class of Fund Shares

The newest share class, developed in 2016, consists of clean shares. Clean shares do not have front-end sales loads or annual 12b-1 fees for fund services. American Funds, Janus, and MFS are all fund companies currently offering clean shares.

By standardizing fees and loads, the new classes enhance transparency for mutual fund investors and, of course, save them money. For example, an investor who rolls $10,000 into an individual retirement account (IRA) with a clean-share fund could earn nearly $1,800 more over a 30-year period as compared to an average A-share fund, according to an April 2017 Morningstar report co-written by Aron Szapiro, Morningstar director of policy research, and Paul Ellenbogen, head of global regulatory solutions.

Advantages of Mutual Funds

There are a variety of reasons that mutual funds have been the retail investor’s vehicle of choice for decades. The overwhelming majority of money in employer-sponsored retirement plans goes into mutual funds. Multiple mergers have equated to mutual funds over time.

Diversification

Diversification, or the mixing of investments and assets within a portfolio to reduce risk, is one of the advantages of investing in mutual funds. Experts advocate diversification as a way of enhancing a portfolio’s returns, while reducing its risk. Buying individual company stocks and offsetting them with industrial sector stocks, for example, offers some diversification. However, a truly diversified portfolio has securities with different capitalizations and industries and bonds with varying maturities and issuers. Buying a mutual fund can achieve diversification cheaper and faster than by buying individual securities. Large mutual funds typically own hundreds of different stocks in many different industries. It wouldn’t be practical for an investor to build this kind of a portfolio with a small amount of money.

Easy Access

Trading on the major stock exchanges, mutual funds can be bought and sold with relative ease, making them highly liquid investments. Also, when it comes to certain types of assets, like foreign equities or exotic commodities, mutual funds are often the most feasible way—in fact, sometimes the only way—for individual investors to participate.

Economies of Scale

Mutual funds also provide economies of scale. Buying one spares the investor of the numerous commission charges needed to create a diversified portfolio. Buying only one security at a time leads to large transaction fees, which will eat up a good chunk of the investment. Also, the $100 to $200 an individual investor might be able to afford is usually not enough to buy a round lot of the stock, but it will purchase many mutual fund shares. The smaller denominations of mutual funds allow investors to take advantage of dollar cost averaging.

Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are lower than what an individual would pay for securities transactions. Moreover, a mutual fund, since it pools money from many smaller investors, can invest in certain assets or take larger positions than a smaller investor could. For example, the fund may have access to IPO placements or certain structured products only available to institutional investors.

Professional Management
A primary advantage of mutual funds is not having to pick stocks and manage investments. Instead, a professional investment manager takes care of all of this using careful research and skillful trading. Investors purchase funds because they often do not have the time or the expertise to manage their own portfolios, or they don’t have access to the same kind of information that a professional fund has. A mutual fund is a relatively inexpensive way for a small investor to get a full-time manager to make and monitor investments. Most private, non-institutional money managers deal only with high-net-worth individuals—people with at least six figures to invest. However, mutual funds, as noted above, require much lower investment minimums. So, these funds provide a low-cost way for individual investors to experience and hopefully benefit from professional money management.

Variety and Freedom of Choice

Investors have the freedom to research and select from managers with a variety of styles and management goals. For instance, a fund manager may focus on value investing, growth investing, developed markets, emerging markets, income, or macroeconomic investing, among many other styles. One manager may also oversee funds that employ several different styles. This variety allows investors to gain exposure to not only stocks and bonds but also commodities, foreign assets, and real estate through specialized mutual funds. Some mutual funds are even structured to profit from a falling market (known as bear funds). Mutual funds provide opportunities for foreign and domestic investment that may not otherwise be directly accessible to ordinary investors.

Transparency

Mutual funds are subject to industry regulation that ensures accountability and fairness to investors.
Pros

• Liquidity
• Diversification
• Minimal investment requirements
• Professional management
• Variety of offerings

Cons

• High fees, commissions, and other expenses
• Large cash presence in portfolios
• No FDIC coverage
• Difficulty in comparing funds
• Lack of transparency in holdings

Disadvantages of Mutual Funds

Liquidity, diversification, and professional management all make mutual funds attractive options for younger, novice, and other individual investors who don’t want to actively manage their money. However, no asset is perfect, and mutual funds have drawbacks too.

Fluctuating Returns

Like many other investments without a guaranteed return, there is always the possibility that the value of your mutual fund will depreciate. Equity mutual funds experience price fluctuations, along with the stocks that make up the fund. The Federal Deposit Insurance Corporation (FDIC) does not back up mutual fund investments, and there is no guarantee of performance with any fund. Of course, almost every investment carries risk. It is especially important for investors in money market funds to know that, unlike their bank counterparts, these will not be insured by the FDIC.

Cash Drag

Mutual funds pool money from thousands of investors, so every day people are putting money into the fund as well as withdrawing it. To maintain the capacity to accommodate withdrawals, funds typically have to keep a large portion of their portfolios in cash. Having ample cash is excellent for liquidity, but money that is sitting around as cash and not working for you is not very advantageous. Mutual funds require a significant amount of their portfolios to be held in cash in order to satisfy share redemptions each day. To maintain liquidity and the capacity to accommodate withdrawals, funds typically have to keep a larger portion of their portfolio as cash than a typical investor might. Because cash earns no return, it is often referred to as a “cash drag.”

High Costs

Mutual funds provide investors with professional management, but it comes at a cost—those expense ratios mentioned earlier. These fees reduce the fund’s overall payout, and they’re assessed to mutual fund investors regardless of the performance of the fund. As you can imagine, in years when the fund doesn’t make money, these fees only magnify losses. Creating, distributing, and running a mutual fund is an expensive undertaking. Everything from the portfolio manager’s salary to the investors’ quarterly statements cost money. Those expenses are passed on to the investors. Since fees vary widely from fund to fund, failing to pay attention to the fees can have negative long-term consequences. Actively managed funds incur transaction costs that accumulate over each year. Remember, every dollar spent on fees is a dollar that is not invested to grow over time.

“Diworsification” and Dilution

“Diworsification”—a play on words—is an investment or portfolio strategy that implies too much complexity can lead to worse results. Many mutual fund investors tend to overcomplicate matters. That is, they acquire too many funds that are highly related and, as a result, don’t get the risk-reducing benefits of diversification. These investors may have made their portfolio more exposed. At the other extreme, just because you own mutual funds doesn’t mean you are automatically diversified. For example, a fund that invests only in a particular industry sector or region is still relatively risky.

In other words, it’s possible to have poor returns due to too much diversification. Because mutual funds can have small holdings in many different companies, high returns from a few investments often don’t make much difference on the overall return. Dilution is also the result of a successful fund growing too big. When new money pours into funds that have had strong track records, the manager often has trouble finding suitable investments for all the new capital to be put to good use.

One thing that can lead to diworsification is the fact that a fund’s purpose or makeup isn’t always clear. Fund advertisements can guide investors down the wrong path. The Securities and Exchange Commission (SEC) requires that funds have at least 80% of assets in the particular type of investment implied in their names. How the remaining assets are invested is up to the fund manager.3 However, the different categories that qualify for the required 80% of the assets may be vague and wide-ranging. A fund can, therefore, manipulate prospective investors via its title. A fund that focuses narrowly on Congolese stocks, for example, could be sold with a far-ranging title like “International High-Tech Fund.”

Active Fund Management

Many investors debate whether or not the professionals are any better than you or I at picking stocks. Management is by no means infallible, and even if the fund loses money, the manager still gets paid. Actively managed funds incur higher fees, but increasingly passive index funds have gained popularity. These funds track an index such as the S&P 500 and are much less costly to hold. Actively managed funds over several time periods have failed to outperform their benchmark indices, especially after accounting for taxes and fees.

Lack of Liquidity

A mutual fund allows you to request that your shares be converted into cash at any time, however, unlike stock that trades throughout the day, many mutual fund redemptions take place only at the end of each trading day.

Taxes

When a fund manager sells a security, a capital-gains tax is triggered. Investors who are concerned about the impact of taxes need to keep those concerns in mind when investing in mutual funds. Taxes can be mitigated by investing in tax-sensitive funds or by holding non-tax sensitive mutual funds in a tax-deferred account, such as a 401(k) or IRA.

Evaluating Funds

Researching and comparing funds can be difficult. Unlike stocks, mutual funds do not offer investors the opportunity to juxtapose the price to earnings (P/E) ratio, sales growth, earnings per share (EPS), or other important data. A mutual fund’s net asset value can offer some basis for comparison, but given the diversity of portfolios, comparing the proverbial apples to apples can be difficult, even among funds with similar names or stated objectives. Only index funds tracking the same markets tend to be genuinely comparable.

A Foreign Institutional Investor is an investor or investment fund which is registered in the country outside the one in which it is investing. They can be insurance companies, hedge funds, mutual funds. This term is generally used in India and it refers to outside companies investing in India.

Usually FII invests in those countries which are developing economies like India. These types of economies provide high potential growth. All of the FII’s must be registered with SEBI to invest in India.

For example:

A mutual fund in the United States sees an investment opportunity in a company of India, it can purchase the equity of that company and can take a long position.

Domestic Institutional Investors or DII are the Indian Institutional Investors who directly invest in the Indian financial markets. Domestic Institutional Investor can be hedge funds, mutual funds, banks, insurance companies, pensions companies.

Types of Orders

The most common types of orders are market orders, limit orders, and stop-loss orders.

• A market order is an order to buy or sell a security immediately. This type of order guarantees that the order will be executed, but does not guarantee the execution price. A market order generally will execute at or near the current bid (for a sell order) or ask (for a buy order) price. However, it is important for investors to remember that the last-traded price is not necessarily the price at which a market order will be executed.
• A limit order is an order to buy or sell a security at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. Example: An investor wants to purchase shares of ABC stock for no more than $10. The investor could submit a limit order for this amount and this order will only execute if the price of ABC stock is $10 or lower.
• A stop order, also referred to as a stop-loss order is an order to buy or sell a stock once the price of the stock reaches the specified price, known as the stop price. When the stop price is reached, a stop order becomes a market order.
• A buy stop order is entered at a stop price above the current market price. Investors generally use a buy stop order to limit a loss or protect a profit on a stock that they have sold short. A sell stop order is entered at a stop price below the current market price. Investors generally use a sell stop order to limit a loss or protect a profit on a stock they own.