A Little Story About Funds

2023-09-25
Summary:

Funds allow for diversification of investments with smaller funds, and different fund types are selected based on their risk tolerance.

Funds may be unfamiliar to some people as they are usually linked to stocks and bonds. Before delving deeper into the concepts and differences between stocks and bonds, you can use a short story to understand them.

A Little Story About Funds

A Little Story About Funds

Assuming someone wants to open a milk tea shop, a total of 100000 yuan is needed, but their funds are only 60000 yuan. He borrowed 20,000 yuan from his friend Xiaoming and agreed to pay 5% interest annually. At this point, Xiaoming became a creditor, and they signed a promissory note as proof.


But even with Xiaoming's 20000 yuan, it is still not enough to meet the funding needs of 100000 yuan. At this moment, another friend, Xiao Qiang, heard about the plan and was willing to sponsor 20,000 yuan, hoping to become a partner and obtain 20% equity. So, they need to sign a formal contract that specifies the equity ratio. Due to the original investment of 80000 and 20000 yuan, Xiaoming holds 80% of the equity and Xiaoqiang holds 20%. From now on, 20% of the profits of the milk tea shop will belong to Xiaoqiang.


Different returns

Now, let's take a look at the returns of Xiaoming and Xiaoqiang in different situations. Assuming that by the second year, the milk tea shop has not paid off 20000 yuan, Xiaoming will receive 5% interest, which is 1000 yuan. If the milk tea shop earns 100,000 yuan this year, then this money has nothing to do with Xiaoming.


But Xiaoqiang owns 20% equity, so out of the 100000 yuan profit earned by the milk tea shop in the second year, they will be allocated 20000 yuan to Xiaoqiang. In the third year, the business of the milk tea shop was not good, earning only 10,000 yuan. However, Xiao Ming's money was still unpaid, so he needed to continue paying an interest rate of 1000 yuan.


Xiaoqiang's situation is somewhat different, as his return depends on the performance of the milk tea shop. In the third year, the milk tea shop only earned 10,000 yuan, while Xiaoqiang could only get a 20% share, which is 2000 yuan. Due to his initial investment of $20,000 being counted as equity, he was unable to recover it.


From this example, it can be seen that Xiaoming's profits are obtained by borrowing money and earning interest, while Xiaoqiang's returns are linked to the performance of the milk tea shop. It can be understood that Xiaoming purchases bonds, while Xiaoqiang purchases stocks similar to stocks. Bonds usually emphasize the safety of the principal and a relatively stable yield, while stocks have greater risk but a higher return.

The concept of funds


Now learn more about what a fund is. The English name for a fund is "Fund", which you may often hear. Funds can be understood in two aspects.


Firstly, a broad sense of fund is established to achieve a certain purpose by gathering funds to meet the needs of individuals, companies, or society, such as social security funds and housing provident funds.


Secondly, narrowly defined funds typically refer to securities investment funds in financial commodities. Securities include valuable certificates such as stocks, bonds, and futures. Before there were funds, investors could directly buy and sell these securities to obtain returns. However, due to the high prices of certain stocks, some people are unable to diversify their investments, as diversification requires a large amount of financial support. At this time, securities investment funds emerged.


Securities investment funds are units sold by fund companies, insurance companies, or banks to attract funds from a large number of investors. These funds are managed by a professional investment management team, forming an independent investment portfolio that includes various valuable certificates such as stocks and bonds.


Diversified investment

Diversified investment refers to investors investing their funds in funds, which fund companies use to purchase various investment products, such as stocks, bonds, etc. This way, even if you have very little capital, you can still invest in diversified assets. Fund companies usually choose different types of fund products based on investors' risk tolerance.


A fund is an indirect investment form that allows investors to diversify their investments into various securities with smaller amounts of funds. Different types of funds have different risks and returns and are influenced by market fluctuations. Before selecting a fund, fund companies usually require investors to conduct a risk assessment to ensure that they choose a fund that is suitable for their risk preferences.


Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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