The building blocks of mutual funds

There tend to be three main ingredients in a mutual fund:

Cash investments are low-risk investments, often government treasury bills. They represent a segment of the financial market often referred to as the ‘money market’ in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, for periods ranging from several days to just under a year. They are secure and tend to grow relatively slowly, but offer investors stable and dependable returns.

Fixed-income investments are debts (or “I.O.U’s”) issued by a company, bank, or government. Investors loan money to the entity (business or government) for a defined period of time at a fixed interest rate. Fixed Income securities are commonly known as ‘bonds,’ and are used by companies, municipalities, states, and national governments to finance a variety of projects and activities.

Investors buy these debts and earn returns as governments and companies pay the interest on their debts and/or pay back the full amount on the agreed upon ‘redemption date.’ The value of these investments can fluctuate with interest rates but still offer a relatively stable and dependable source of income through interest payments and upon redemption.

Equities are ownership shares (or “stocks”) in companies. They tend to offer the highest rate of return, but also carry higher levels of risk. Investors can purchase stocks in companies they feel are sound businesses demonstrating solid earnings, or businesses they believe have high potential for growth. Through their share of ownership, they can participate in the company’s profits through increased share value as the stock price rises, or through ‘dividends’ – periodic payments given out by some companies as a share of profits to their shareholders. It is important to be aware that share prices can also decrease if companies report losses, or even face bad press or negative customer reaction to a new product or policy. This is where the risk of equities lies. On average, however, stocks have outperformed most other investments over the long run. This is why they form the foundation of most investors’ portfolios.