There are a number of options you can choose to invest your money, but you have to decide on the right one. Even when you are no longer a novice investor, there are still many ways to learn to invest and determine where to put your money.
Have you heard of hedge funds and mutual funds? How can you decide which is better for you? It helps to know the difference between a hedge fund vs mutual fund before making your move. Look at this guide to understand the similarities and differences of each.
What Is a Hedge Fund?
A hedge fund is a pooled account that is usually offered privately to those who are investors. This is because they must follow rules of Regulation D of the Securities Act of 1933 that state only accredited investors may participate.
In order to be an accredited investor, you must make a minimum of $200,000 as an individual or $300,000 for a joint couple. These investors are those with a high net worth, brokers, banks, trusts, or insurance businesses.
Hedge funds are viewed as aggressive because investing comes with a lot of risks. However, this is attractive to many investors who understand this method offers higher returns. Investors will use leverage or short sales as methods to gain these returns.
Hedge funds can limit the ability of investors to access funds within set periods in the year. There are times these funds investors will not be able to access those funds if there is an initial lockup period (usually a year).
With a hedge fund, investors continue to invest regardless of how good or bad the market is doing. If the market may drop, managers of these funds will complete shorting stocks.
The success of returns depends on the ability of the manager to anticipate shifts in the market and knows how to respond. Even with the coronavirus pandemic, big gains still prove to be possible.
This result may or may not happen depending on the quality of management and strategies used. Large hedge funds that have huge assets dominate the market.
Types of Hedge Funds
Since hedge funds are private vehicles, they have the ability to do what they want. The only thing is they must be upfront to investors. Hedge funds may invest in anything such as currencies or real estate and equity. Hedge funds also invest in stocks and bonds while keeping constant changes into consideration (interest rates and economic policies).
What Is a Mutual Fund?
Mutual funds are managed by professionals who use a less aggressive investment style compared to hedge funds. It typically focuses on investing in bonds, stocks, and money market instruments to pool money from a variety of investors.
Mutual funds are available to public investors passive and active ways to manage investments. They also have low investment requirements, and in some cases, you can start with as little as $100. In regards to liquidity, investors may sell shares one day and complete the sale that day so long as they have their trade available by the given deadline.
When funds are actively managed, the manager decides what securities to own and which to exclude. Those that are managed in a passive way track market benchmarks and rely on index funds.
They are regulated by exchanges which makes it mandatory for mutual funds to release a prospectus stating the objective of the fund and what strategies are or will be implemented.
Mutual funds are beneficial because they offer transparent reports each year along with performance and disclosures. The increased diversity toward securities also offers lower concentration risk.
Types of Mutual Funds
There are three main types of mutual funds. The most common are open and closed-ended mutual funds, but unit investment funds are also something the trust will use.
Open-Ended Mutual Funds
Open-ended mutual funds allow investors to purchase and sell units any time they want at the Net Asset Value (NAV). The NAV is determined by the price of securities the fund owns. The main advantage is investors can use this as a cushion while enhancing returns during downtimes on the market.
Closed-Ended Mutual Funds
Close-ended mutual funds provide shares during Initial Public Offering which is only done once. The shares placed for stock exchange are only sold to other investors with the market, not toward the fund. The price investors can ask for varies from that NAV. The investor may be able to sell it at a discount or premium.
Unit Investment Funds
Unit investment funds are US-based financial companies that either buy or hold securities. They later make these securities, typically stocks and bonds, available for investors to redeem for a certain amount of time. Investors have the choice to redeem their shares around that time otherwise they will have to wait until the trust is terminated.
Hedge Fund vs Mutual Fund: Similarities
Mutual and hedge funds do have a lot of similarities. For one, they both pool investment tools where you add money to a number of investors in a single portfolio. Both offer some level of diversity when holding multiple securities in regard to the fund’s objective.
They are also professionally managed by an overseer who buys and sells securities based on the market and their opinion among other factors. One important thing to keep in mind with both is that there are certain expenses to know.
Mutual funds may have back-end or up-front sales charges while hedge funds have yearly management fees, including a performance fee in the event certain objectives are satisfied. Understanding and weighing these costs are crucial for returns.
Which of the Two Is Best for You?
Individuals and businesses alike have the same desire to grow the money they make at a rapid pace. Both hedge funds and mutual funds pool money from many investors to gain profit quickly and are managed by an experienced fund manager.
When you are picking from a hedge fund vs mutual fund, you are weighing between larger returns and risks. Keep in mind, mutual funds are more accessible. When you want to try hedge funds, you must meet the requirements.
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