Understanding mutual funds

Mutual funds are often considered a cost-effective way to diversify your investment portfolio. By combining your money with other investors, you can access a range of stocks, bonds, and other securities with just a single investment. On this page, we discuss how mutual funds work, their benefits, and what to consider if you’re thinking of investing in mutual funds.

Mutual funds are investment options where many investors pool their money to buy a variety of assets. These securities might include anything from stocks and bonds to short-term debts, depending on the fund’s goals.

When you invest in a mutual fund, you buy shares in that fund, giving you ownership in all the assets it holds. Fund experts then decide which investments to buy and sell, aiming to grow the fund’s value and generate income. This professional management often makes mutual funds a less risky option compared to investing on your own.

In Ireland and across Europe, you might hear them called open-end funds. This definition of mutual funds refers to the fact that you can buy and sell shares at their net asset value (NAV) on any trading day. Investing this way spreads your money across different assets (known as diversification), which can also help reduce risk compared to investing in individual stocks or bonds.

Mutual funds generate returns for investors in a few different ways:

• First, they earn income from the securities they hold, such as dividends from stocks and interest from bonds, which is usually passed back to investors throughout the year. 

• Also, the fund’s value can increase if its investments rise in price (capital appreciation). These returns are distributed to investors as cash payments or additional shares in the fund.

• A third option for returns comes from individual sales. If the fund’s assets increase in price, but the fund managers choose not to sell them, you can still sell your mutual fund shares on the market to secure a profit based on the increased value of the fund’s assets.

However, there are costs involved. When you invest in a mutual fund, you pay fees for its ongoing management, known as the expense ratio. This can range from very low to over 2% of the fund’s total assets. Some funds may also charge a sales commission when you buy or sell shares. And in Ireland, it is particularly important to be aware of the exit tax that will lower your potential returns.

Each type of mutual fund comes with its own level of risk, and is designed to achieve specific investment outcomes. 

Here are some examples of mutual funds:

1. Equity funds: Also called stock funds, these funds mainly invest in shares of companies. You might come across funds that focus on companies in Ireland, Europe, or worldwide. Equity funds can have different goals, like investing in companies that are growing quickly, those that are seen as undervalued, or those that pay regular dividends.

2. Bond funds: This type of mutual fund invests in various types of bonds, like government or corporate bonds. They aim to provide regular income through interest payments. Bond funds can vary widely: some invest in safer government bonds, while others might choose riskier corporate or high-yield bonds.

3. Money market funds: These investment funds focus on high-quality debt from governments. Money market funds are often used to invest surplus cash for the short term and are considered a safer investment option. They aim to preserve your capital while offering quick access to your money, with returns typically aligned with Central Bank deposit rates.

4. Index funds: Index funds track the performance of a specific market index, such as the ISEQ Overall Index, which reflects the Irish stock market. These funds aim to mirror the performance of the index rather than outperform it, meaning they are often more cost-effective with lower management fees.

5. Balanced funds: These mutual funds mix different types of investments, like stocks, bonds, and cash. This mix helps spread out risk while aiming for steady growth. Balanced funds adjust their investments based on current economic conditions and what investors want.

6. Income funds: Designed to provide a steady income, these funds invest in fixed-income securities like bonds or dividend-paying stocks. Income funds may include a mix of local and international assets. Because they give investors a reliable flow of cash, some consider them suitable as an income to support retirement.

7. Global and regional funds: Global funds spread your investment across many countries, giving you broad diversification, but also exposing you to global market ups and downs. Regional funds, on the other hand, concentrate on specific areas, like Europe or emerging markets.

8. ESG funds: Also called socially responsible funds, these invest in companies that aim to make a positive impact, like cutting carbon emissions or supporting fair labour practices. ESG funds let you invest in a way that aligns with your values while still aiming for good returns. In Ireland, these funds reflect the growing trend towards sustainable finance.

Investing in mutual funds involves several considerations. Firstly, mutual funds in Ireland are regulated by the Central Bank of Ireland and follow EU rules, which provides some protection. However, many funds invest in assets not denominated in euros, which can affect your returns.

One of the most important things to look at with mutual funds are the associated fees. Besides the usual management and entry/exit fees, some funds may also charge a redemption fee if you sell shares shortly after buying them. Comparing these costs across different funds can help you find an option that lets you keep more of the investment gains from your portfolio.

Investors will of course consider their risk tolerance and ultimate goals. Reviewing the fund’s past performance and the reputation of the fund manager can also help you decide. A solid track record can be a good indicator of future performance.

This information does not constitute financial advice. You should always do your own research to ensure that investments are right for your specific circumstances.

While Ireland is a major hub for global investments, the tax rules for mutual funds can be slightly off-putting for local investors.

If you hold a mutual fund for over eight years, you’ll need to pay tax on any gains you’ve made. This tax is charged at a 41% rate, and it applies whether you’re selling the investment fund or just holding on. This means you might face a significant tax bill without even cashing in your mutual fund investment, which can impact the long-term performance of your fund.

However, the Irish government is aware of these issues and is looking into possible changes.

In Ireland, some providers specify a minimum mutual fund investment of around €5,000, and you’ll typically need to keep this money invested for at least five years.

The right amount for you will really depend on your personal financial goals, how much risk you’re comfortable taking, and any other financial commitments you have. Some like to follow a budget such as the 50/30/20 rule, where you subtract your fixed expenses from your monthly post-tax income, and invest or save the rest. 

For more specific advice on how much to invest based on your individual situation, it can help to consult with a financial advisor.

If you’ve come into a lump sum of money—whether from an old savings plan, an inheritance, or a redundancy payout—and you’re thinking about where to invest or save it, mutual funds could be worth considering. Because they’re managed by experts, you don’t have to worry about getting overwhelmed choosing from one of the many different individual investments yourself.

If the cost of the fees is a concern, there are alternative options available, such as exchange-traded funds (ETFs). ETFs tend to have lower fees because they are often passively managed, whereas the active management of mutual funds naturally pushes up their fees. Also, you can buy or sell ETFs at various prices during market hours, while mutual funds are only bought or sold at the end of the trading day, based on the fund’s value at that time.

That said, it’s worth remembering that investing is never without risk. Even though mutual fund investments can be one of the more beginner-friendly options, there’s always a chance you could lose some or all of your initial deposit.

If the idea of risk makes you uncomfortable, a high-interest savings account could be a safer alternative. With competitive rates on fixed term deposits, you can still earn a decent return on your savings, plus enjoy the added security of the Deposit Guarantee Scheme, which protects up to €100,000 per depositor and bank if something goes wrong.

If you’re keen to avoid risk involved with investing in mutual funds, a savings account could be a better choice for you. Fixed term deposits, in particular, offer a guaranteed, competitive interest rate, so you know exactly how much you’ll earn. Register for free with Raisin Bank to explore your savings options and find the best rates for you.