Beginner’s Guide to Mutual Funds: Benefits, Types, and How They Function

Mutual funds are investment vehicles that gather capital from a multitude of investors, using this pooled money to invest in a diversified portfolio of securities, which can include stocks, bonds, and other assets. Investors then own shares of the fund, representing a proportional stake in its overall holdings.

In Singapore, mutual funds often provide an accessible entry point to diversified investing, particularly beneficial for those new to investing or those seeking professional portfolio management.

Mutual funds offer several compelling advantages for investors:

Diversification: By spreading investments across various assets, mutual funds reduce overall portfolio risk.

Professional management: Fund managers with expertise make investment decisions on your behalf, saving you time and effort.

Liquidity: Mutual fund shares can be easily bought or sold, offering flexibility.

Accessibility: In Singapore, mutual funds are readily available through banks and online platforms, making them accessible to a broad range of investors.

Mutual funds operate by pooling resources from individual investors. The fund manager then uses this collective capital to invest in a variety of securities. The fund’s value is determined by its Net Asset Value (NAV), which is calculated daily based on the market value of its assets. A management fee, typically an annual charge, covers the costs of professional portfolio management.

In Singapore, you can invest in mutual funds through major banks, online investment platforms, or via financial advisors, offering diverse avenues for participation.

Mutual funds can generate returns through several avenues:

• Dividend payments: Mutual funds invest in a variety of securities, including stocks and bonds, which may generate dividends or interest income. When the fund receives these payments, it typically distributes a proportionate share to its investors. This distribution can be taken as cash or reinvested back into the fund to purchase additional shares, compounding your potential returns over time. In Singapore, this is a common way for investors to see regular, albeit potentially variable, income from their mutual fund investments.

• Capital gains: When a mutual fund manager sells securities within the fund's portfolio for a profit, this results in a capital gain. These gains, net of any capital losses, are generally distributed to investors annually. The amount of capital gains distributed depends on the fund manager's trading activity and the performance of the fund's holdings. In a rising market, capital gains distributions can significantly contribute to an investor's overall return.

• Net Asset Value (NAV): The Net Asset Value (NAV) of a mutual fund represents the market value of its assets minus its liabilities, divided by the number of outstanding shares. As the value of the securities held by the fund increases, the NAV per share also rises. This appreciation in NAV reflects the growth of your investment. Unlike dividends and capital gains, which are distributed to investors, NAV appreciation increases the underlying value of your fund holdings. If you decide to sell your fund shares, you would realise this gain.

It's important to remember that while mutual funds offer the potential for returns, they also carry risk. Market fluctuations can impact the value of fund holdings, and past performance is not indicative of future results.

Mutual funds come in various forms, each with its own risk and return profile:

Stock funds, also known as equity funds, focus their investments primarily on company stocks. These funds offer the potential for higher returns, particularly in growing economies. However, they also carry a higher degree of risk, as stock prices can fluctuate significantly based on market conditions, company performance, and global economic factors.

Within equity funds, there are various sub-categories, such as growth funds (focusing on companies with high growth potential), value funds (investing in undervalued companies), and sector-specific funds (concentrating on specific industries like technology or real estate).

Money market funds are designed to provide stability and capital preservation. They invest in highly liquid, short-term debt securities, such as treasury bills, commercial paper, and certificates of deposit. These instruments are generally considered low-risk, making money market funds a safe haven for investors seeking to protect their capital.

However, the trade-off is lower returns compared to other fund types. In Singapore, these funds are often used by investors looking for a secure place to park their cash while earning a modest return, or as a temporary holding before investing in other asset classes.

Bond funds invest in a diversified portfolio of bonds, which are debt securities issued by governments or corporations. They offer a balance between risk and return, typically being less volatile than stock funds. Bond funds can provide a steady stream of income through interest payments, making them attractive to investors seeking regular payouts. 

Different types of bond funds exist, including government bond funds, corporate bond funds, and high-yield bond funds, each with varying levels of risk and return.

Balanced funds, also known as hybrid funds, aim to provide a mix of growth and stability by investing in both stocks and bonds. The allocation between stocks and bonds is typically determined by the fund manager based on market conditions and the fund's investment objective. This diversification helps to reduce overall portfolio risk.

Balanced funds are suitable for investors seeking a moderate risk-return profile. In Singapore, these funds are popular among those who prefer a "one-stop" investment solution, offering exposure to both equity and fixed-income markets.

The 3-fund portfolio strategy is a popular, simple, and effective approach to building a diversified investment portfolio. It's designed to be low-cost and easy to maintain, making it ideal for both beginner and experienced investors. This strategy involves investing in just three broad, low-cost index funds or ETFs, providing exposure to a wide range of asset classes.

The core components of a 3-fund portfolio are:

1. A total Singapore stock market fund (or a broad Asia Pacific ex-Japan stock market fund): This fund provides targeted exposure to the Singaporean stock market, capturing the performance of companies listed on the SGX. Alternatively, a broader Asia Pacific ex-Japan fund allows participation in the growth of diverse regional economies, including emerging markets. For Singaporean investors, this means direct involvement in the performance of familiar local blue-chip companies, REITs, and other key sectors, or tapping into the wider growth potential of the region.

2. A total world stock market fund (ex-Singapore): This fund offers crucial diversification beyond the local market, providing exposure to a wide spectrum of global equities. By excluding Singapore, it prevents over-concentration in the domestic market, mitigating risks associated with local economic fluctuations. For Singaporeans, this means access to leading international companies and diverse sectors, helping to balance the portfolio and reduce reliance on Singapore's specific market conditions.

3. A Singapore government bond fund (or a global aggregate bond fund): This fund provides a stable foundation for the portfolio through investment in fixed-income securities. Singapore Government Bonds, known for their high credit rating, offer a safe haven, particularly during market volatility. Alternatively, a global aggregate bond fund can provide an even greater level of diversification across various bond markets. Regardless, investing in such a fund provides a reliable income stream and a buffer against potential equity market downturns, aligning with a prudent approach to responsible investing.

The appeal of the 3-fund portfolio lies in its simplicity. By investing in these three broad funds, you achieve significant diversification across stocks and bonds, reducing risk. This strategy is also cost-effective, as index funds and ETFs typically have low expense ratios.

For Singaporean investors, this strategy can be easily implemented through local brokerages or robo-advisors that offer access to these types of funds. It's a "set it and forget it" approach, requiring minimal maintenance and rebalancing over time, which makes it an excellent choice for those looking to build long-term wealth without actively managing their portfolio.

Pros:

• Simplified investment process: For busy Singaporeans, mutual funds streamline investment. Fund managers handle market analysis and portfolio adjustments, saving you time and effort. This is especially valuable in Singapore's fast-paced environment, where time is a premium.

• Access to specialised markets: Mutual funds allow you to tap into niche markets or asset classes that may be difficult to access directly. For instance, you can invest in emerging market equities or specialised bond funds, offering diversification beyond Singapore's local market.

• Regular savings plans: Many mutual funds in Singapore offer regular savings plans (RSPs), allowing you to invest a fixed amount regularly. This encourages disciplined investing and aligns with Singapore's emphasis on long-term financial planning.

• Transparency and regulation: Mutual funds in Singapore are subject to stringent regulations by the Monetary Authority of Singapore (MAS), providing a level of investor protection. Fund managers are required to disclose fund holdings and performance, ensuring transparency.

Cons:

• Potential for underperformance: Actively managed mutual funds may underperform benchmark indices, especially after accounting for fees. This is a crucial consideration for cost-conscious investors who prioritise value.

• Distribution of capital gains: Capital gains distributions, while a source of return, can impact your overall investment position, even if you reinvest the gains, as the reinvestment changes the cost basis of your holdings.

• Market risk: Although mutual funds offer diversification, they are still subject to market risk. During market downturns, the value of your fund holdings can decline, regardless of the fund manager's expertise.

• Limited customisation: Unlike direct stock investing, mutual funds offer limited customisation. You cannot select individual securities, and your portfolio is determined by the fund manager's strategy.

Navigating the mutual fund landscape in Singapore involves choosing between several distinct avenues, each with its own set of advantages. The right choice depends on your investment style, experience, and the level of support you require.

• Major banks (DBS, OCBC, UOB): These banks offer a familiar and secure environment, particularly attractive for those who already manage their finances with them. They provide access to a curated selection of funds, often accompanied by educational resources and personalised consultations, which can be invaluable for novice investors. Their integrated online platforms simplify tracking investments alongside daily banking activities.   

• Robo-advisors (StashAway, AutoWealth, Endowus): For digitally inclined investors seeking automation, robo-advisors present an efficient solution. They employ algorithms to construct and manage diversified portfolios, adjusting them based on your risk profile. This is ideal for those who prefer a passive investment strategy and appreciate the lower fees typically associated with these platforms.   

• Online platforms (Fundsupermart, Maybank Kim Eng): These platforms cater to the more hands-on investor, offering a comprehensive marketplace where you can compare and select from a wide array of mutual funds. They provide tools for in-depth research and analysis, empowering you to make informed decisions and actively manage your portfolio.   

• Financial advisors: When personalised guidance is paramount, financial advisors offer tailored investment strategies. They consider your unique financial circumstances and goals, providing recommendations that align with your long-term objectives. This is particularly beneficial for complex financial planning, such as retirement or estate management.

Identifying top-performing mutual funds in Singapore requires a combination of research, due diligence, and an understanding of your own investment goals. While past performance is not indicative of future results, it can provide valuable insights into a fund's track record and management strategy.

When evaluating fund performance, it's essential to consider several factors beyond just the raw returns. Look at the fund's consistency over different market cycles, its expense ratio, and its risk-adjusted returns (e.g., Sharpe ratio). A fund with consistently strong performance and a low expense ratio is generally more attractive.

For those interested in specific investment themes, such as sustainable investing or technology, consider funds that align with your values and goals.

Identifying top-performing mutual funds in Singapore requires a combination of research, due diligence, and an understanding of your own investment goals. While past performance is not indicative of future results, it can provide valuable insights into a fund's track record and management strategy.

When evaluating fund performance, it's essential to consider several factors beyond just the raw returns. Look at the fund's consistency over different market cycles, its expense ratio, and its risk-adjusted returns (e.g., Sharpe ratio). A fund with consistently strong performance and a low expense ratio is generally more attractive.

For those interested in specific investment themes, such as sustainable investing or technology, consider funds that align with your values and goals.