What are Mutual Funds?
To many people, Mutual Funds can seem complicated or intimidating. Lets us try and simplify it at its very basic level. Essentially, the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund. This fund is managed by a professional fund manager.
How do Mutual Funds work?
It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor owns units, which represent a portion of the holdings of the fund. The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV. Simply put, a Mutual Fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. For example, large-cap Mutual Funds will only invest in large-cap stocks. So if you have put your money in a large-cap Mutual Fund, then you are aware of where your money is being invested.
Mutual Funds are not only for stock market investing
The biggest misconception about investing in Mutual Funds is – investors usually assume that Mutual Funds only invest in the stock markets. But, this is not exactly true. If you are a conservative investor, and you do not prefer to take too much risk, then through Debt Mutual Funds, you can also invest in debt instruments, where the risk factors are much less.
Hence you can choose Mutual Funds, as per your risk appetite, investment horizon, or your investment objectives. You can choose a Mutual Fund that fits your criteria perfectly.
How Mutual Funds invest their money and how they generate returns?
The fund manager of Mutual Fund conducts in-depth research and analysis around the stocks and debt instruments. And based on the research, they invest your money.
Now when you invest in a Mutual Fund scheme, the Asset Management Company or AMC allots you the units as per the NAV of the Mutual Fund. For example, let’s assume that you have invested Rs 20,000 in a Mutual Fund, for which the NAV is Rs 20. That way, the AMC will allot you 1000 units of a Mutual Fund scheme.
To sum it up, your money is indirectly invested in stock markets or the instrument in which the fund manager has invested the money.
Now, let’s assume you have invested Rs 20,000 on a Mutual Fund scheme, for which the AMC has allotted you 1000 units for the NAV of Rs 20. In the second year, the NAV for the Mutual Fund becomes Rs 22. That means in the last one year, you have earned a 10 percent return on your Mutual Fund investment. So this way you can track your investments to know what kind of returns you are earning on your investments.
Can I create my portfolio of my own, the way the Mutual Funds do?
You should not bother about creating a portfolio. This is simply because, when a fund manager creates a portfolio, he/she provides the utmost importance to risk management, which is difficult for a retail investor to figure out. So when you invest in Mutual Funds, the fund’s manager, who is an expert in the field, does the same job (i.e. create a portfolio) on your behalf.
Types of Mutual Funds:
There are three types of Mutual Funds. And, it is essential to have knowledge of all three of them to choose the right Mutual Fund for making your investment. This classification is made based on the underlying assets.
As an investor, the next relevant question is what are the benefits of investing in Mutual Funds?
Here are the some benefits of investing in Mutual Funds
#1: Mutual Funds are Tax-effecient:
If you are in the highest tax bracket, then the tax amount for your Mutual Fund investments will be much lower than traditional investment options like fixed deposits.
#2: Provide good Long Term Returns:
If you invest in Mutual Funds for the long term, then it is possible that the Mutual Fund scheme will provide higher returns as compared to fixed deposits. If you look at the long term returns of Mutual Funds, though there are no guaranteed returns, they usually provide higher returns than traditional investment options.
So if you want to grow your money, you can invest in Mutual Funds, so that you earn higher returns than other traditional investments like fixed deposits.
#3: Regulated by SEBI:
All Mutual Fund schemes are regulated by the Securities and Exchange Board of India or SEBI. It ensures that there is enough transparency in the market.
#4: Several funds to choose from:
Over 1000 Mutual Fund investment schemes are available in the market, and you can choose to invest as per your investment horizon, risk appetite and investment objective.
Summary:
A Mutual Fund is an excellent investment tool to grow your money. But, many times investors shy away from investing in Mutual Funds thinking it to be a risky product, simply because they are market-linked. If an investor picks a fund as per his/her investment horizon and objective, then there is no way one can go wrong by investing in Mutual Funds.
