The Distinguishing Feature Of Stock Fund Rates And Bank Account Rates

One way to measure the strength of an investment is through its “rate”. It is an expression for calculating how much profit it makes during the period of investment. A simple example may help. A customer of a bank puts in $100 into a certificate of deposit (CD). The rate is given as 5% per annum. Therefore, at the end of the 365 day period, the customer may expect to cash out at $105. In more detail, it is expected that the CD is continuously earning profit so that even if the customer cashes out in the middle he or she can receive some compensation.

Some financial instruments have fixed rates as discussed above. Bank savings accounts, certain government bonds and certificate of deposits all give exact returns as indicated by their rate. But there are many more investment instruments that do not have true rates. For example, a share of stock in a high yield mutual fund for a certain company has no intrinsic rate. For example, an investor puts $1000 into some shares of stock for a company. After some time, the stock may have higher or lower value. There is no guarantee that the investor has more or less $1000 at the end of any period.

Stock market mutual funds are much the same way. Since each fund is really a portfolio of many stocks, the value of a mutual fund fluctuates according to the underlying prices of the portfolio stocks. For investors then, the confusion lies in what the advertised “rate” of a mutual fund means. Occasionally mutual funds are termed high yield mutual funds, but the investor should understand the meaning of high yield mutual fund.

Mutual fund rates are a way for mutual fund companies to advertise their products. However, the rates are really “historical rates of return” which mean that they show how the mutual fund gained in value over time, but do not indicate any future behavior for the fund in question. Mutual fund companies like to advertise these rates to make the consumer feel more secure, but there will always be a disclaimer at the bottom of these advertisements that say the “historical rates” are not expected to hold in the future.

Mutual funds fluctuate in value for several reasons. One of them is that stocks fluctuate in value, and sometimes they all go up or all go down together during boom and bust times respectively. In addition, irrespective of whether it is economic boom or bust, individual companies hit hard times and can drop in value. Finally, companies occasionally issue “dividends” which are direct payouts to shareholders from profits of the previous year or quarter. Dividends help increase the value of a mutual fund that holds shares of such companies.

The key point to remember is that rates, for example of stock, bond and GNMA mutual funds, are only historical rates, and are not the same as rates for fixed income securities like savings accounts, bonds and certificates of deposit. High yield mutual funds should also be interpreted in this light.

Many of these ideas were generously distributed by a website on high yield bond funds. The articles provided for screener mutual fund will be informative to many.