Investing 101: How does a hedge fund work?

Nowadays, investors have various options in the stock market. A pooled investment vehicle is one way of investing your money into the stock market with other investors.
First of all, let’s understand what a pooled investment vehicle is. Several investors put their money into the pool to buy shares in the investment. Returns are realized in the form of dividends or an appreciation of price as the investment per share increases. Compared to other investment pools, hedge funds are more expensive because there are asset management fees about 2%, as well as additional costs amounting to 20% of overall profits.

Throughout the last twenty years, hedge funds have had an exceptional growth curve. You can invest in anything with hedge funds: land, real estate, derivatives, or stocks. That is what differentiates hedge funds from mutual funds, where you have limitations to investing in stocks and bonds only. As for now, by most estimates, hedge funds operate collectively over $1 trillion worth of assets.
The characteristics of hedge funds include that they are only open to accredited or qualified investors. These types of investors usually include the ones who meet specific net worth requirements, such as a net worth exceeding $1 million or an annual net income of $200,000 for the past several years.

It has a very large investment latitude meaning you can invest in land, buildings, real estate, stocks, bonds, etc. So, you have wide options while choosing what you want to invest in. Hedge funds use leverage or borrowed money to amplify returns, which are also a factor exposing them to larger investment risks. The wide latitude may sound risky, and in fact, it is. But, in the case of proper planning and budgeting, hedge funds provide investors with higher yields in different economic sectors. Another difference from mutual funds is that hedge funds have very limited regulation from the Security and Exchange Commission, because of the fact that the main players in hedge funds are accredited or qualified investors. Although some funds work with non-accredited investors, the US securities laws dictate that if the majority of hedge fund participants are qualified, there is no breach.
The overall advantages of hedge funds include a great variety of investment options in different sectors, higher returns, and lower risks due to diversified portfolio as well as they are managed by the top investment managers. On the other side, if investors are looking for liquid investment techniques, mutual funds are a better option. Hedge funds usually require investors to lock up their money for a period of years in order to gain higher returns. Other than that, as already mentioned, not all investors can participate in hedge fund investments, they need to be accredited in order to put their money in this investment vehicle. 
All in all, hedge funds have become so widely used and powerful that the Security and Exchange Commission started to pay closer attention compared to previous years when mutual and other types of funds were under strict regulation.
February 4, 2020

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