KNOWLEDGE CENTRE Mutual Fund Basics / What Is A Mutual Fund?
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What Is A Mutual Fund?


Mutual funds are investment programs that pool money from people and invests in securities like stocks, bonds, money market instruments or even other mutual funds. Mutual fund investments are a good option for investors who do not have the time, knowledge or experience to invest directly.

Investors in mutual funds have a common objective and their money is invested in different asset classes in according to the mutual fund’s objective. Mutual funds are an affordable option to investor’s portfolio as they are able to invest in multiple instruments without having to pay the entire cost of all the instruments.

Mutual funds can be actively managed by professional fund managers or passively managed based on an index or sector. Mutual funds are generally well diversified with investments across different sectors to offset potential losses.

How Do Mutual Funds Work?

Some believe that mutual funds are an investment option only for the rich. But, it is not true and the investment can be done by everyone. A person who wants to invest should appoint a fund manager who has expertise in this field. There are banks and businesses which specialize in this kind of investing. These organizations appoint a personal funds manager, especially for your needs. Since mutual funds offer a structured portfolio for investment it is easy to discuss the best options with the fund manager. The manager prepares a detailed portfolio and the duration of the investment.

Let us take an example here to understand how mutual funds work. John wants to invest in mutual funds, but has only $50 to begin investing. He wants to invest the money in 50% stocks, 30% bonds and 20% in cash. But he cannot do so alone due to lack of cash. So he brings in others who can invest with him. The money manager makes the investment in the proportion he feels that would give everyone good returns. He prepares a portfolio for each of them. Now, depending upon the contribution made, the investors will get back their returns at the end of the duration.

What Are The Basic Types of Mutual Funds?

There are mainly 2 types of mutual funds.

  • Closed End Mutual funds – These have a fixed number of shares outstanding and operate for a fixed during of time. It is generally for 3-15 years. They are also listed on stock exchanges and traded just like other stocks.
  • Open Ended Mutual Funds – These are available throughout the year and not listed on stock exchanges. Majority of the mutual funds are open ended mutual funds. The investors can buy or sell stocks at any point of time.

What Are The Benefits of Investing in Mutual Funds?

Mutual funds give small investors a chance to invest in many portfolios like equities, bonds, and other securities. This can be done by bringing in together a pool of people.

Liquidity

One of the major benefit of investing in mutual funds is liquidity. It means one can access the invested money on a short notice when in need. It is not frozen unlike other investment options like FDIs.

Investing in mutual funds also provides diversification. For example, stock markets are always uncertain. One cannot escape it, but the experts believe and follow a simple rule to cut risks. They invest in different sectors like real estate, automobiles, energy and so on. Hence, your money will always be at least risk. Besides, the profits will be better.

• SEBI Controls Investment

Another major advantage of investing in mutual funds is that it is regulated by SEBI. Hence, the chance of fraud is also minimized or rather not there at all. All the mutual fund’s investment is registered with SEBI. They function under strict rules which protect the interest of the investor.

• Tax Benefit

The biggest advantage of investment in mutual funds is saving on tax by investing in tax saving mutual funds. The government cannot tax on the income and profits in compliance with certain rules. Today, it plays an important role in many households, especially for retirement planning.

• Low Charges

Since the investment is done by a large pool of people, the charges from your side to the bank or the organization is low.

Less than 10% of the Indian households make an investment in mutual funds. This is due to lack of information on how mutual funds work. The people also find it risky which is not true.

Why Should You Invest In Mutual Funds?

The different types of mutual funds come with their own set of goals. For example, the objective of a growth stock fund might be to provide long-term appreciation. This could be for retirement, child’s education or any other needs. Below are some of the primary advantages of mutual funds.

  • Many prefer stocks which provide rapid growth but has a high element of risk with them. The quick growth stock often lose value quickly when the economy suffers. But it is a great option for someone who do not need money for the next 5 years.
  • Sticking with medium-long term investments provides better benefits in the long run. But, this is highly volatile and one should remain patient when investing.
  • The income funds have a mix set of goals. These funds provide the investors with current income and show potential for growth in the future. They also fulfill multiple objective. Retired investors can benefit from such mutual funds
  • The money market mutual funds aim at maintaining capital preservation. These funds offer less risk but do not fare well on the inflation side of the market. But, these are highly flexible and one can keep altering the strategy from time to time.

Now that you have a basic understanding of how mutual funds work, why should you really invest in them? They are the best investment options which help investors generate better inflation-adjusted returns. In addition, it is an ideal investment option so that the purchasing power of your hard earned money does not drop over a period of time.

Each form of investment provides risk. But skillful management, diversification of mutual funds and sound securities can help reduce risks and provide better returns in time. The fund managers provide regular information about strategies, the current value of the investment which gives a better picture of investments. In addition, since it is regularized by SEBI, you can be assured that your money is in safe hands. The investment of mutual funds will be done in a disciplined and a regularized manner. Also, you have options for investment in different sectors and industries both domestically and internationally.


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