What is mutual fund : learn basics before investing

We many times get advice that investment in mutual funds gives huge return. What is mutual fund and how does it work? You need to learn some basics of mutual funds before investing. Read the post to understand upsides and downsides of the mutual funds investing and how choose the products that matches the investor financial goals and risk tolerability.

What is mutual fund ?

What Over the years, the investors have turned to Mutual Funds to save for the retirement and other financial goals such as child education, buying a House, Automobile Purchase etc. Well, the Mutual Funds can provide the advantages of diversification and professional management. But, this too involves risk as compared to other investment instruments. Further, now a days, the fees and taxes also diminishes the investor return.

Mutual Fund is a company that pools the money from many investors and invests the money in stocks, debentures, short term money-market-instruments, other securities or assets, or some combination of these assets. The combined holding that the mutual fund owns is known as its Portfolio. Each share represents an investors proportionate ownership of the fund’s holdings and the income those holdings generate.

Some of the Pertinent Characteristics of Funds

• Investors purchase mutual fund shares from the fund itself (or through a broker of the fund) instead of from other investors in a secondary market such as NSE, BSE etc.
• Generally, the investors buys the mutual funds on the basis of the fund’s per share net asset value plus any fees that the fund imposes at the time of sales (such as sales load).
• Further, it is be noted that the mutual funds share are redeemable at any time i.e. they can be resold by the investor at any time to fund itself.
• When funds become too large they sometimes stop selling, but other they are of continuous nature.
• The investment portfolios of mutual funds typically are managed by separate entities known as “investment advisors” that are registered with the SEBI.

Major Advantages & Disadvantages of Mutual Funds

I hope you got some idea about what is mutual fund. Mutual Funds come with lots of advantages but here are few important ones that me be depend upon the circumstances of the individual.

• Management of Your Money by Professionals:Almost every mutual fund is being managed by the professionals having a good hand in the market and therefore, you are giving your money into some good hands at first sight.

• Diversification of Risk: Everyone must have hear that “Don’t Put All Your Eggs in One Basket”, therefore by spreading the investment wide across the industries can really mitigate your losses in future. Many investors find that investing in a mutual fund will be more beneficial than investing in a particular stock or bond.

• Affordability: Many Investors find that investment in a mutual funds at the initial stages of investment will be more affordable than investing in a stock considering other aspects also like risks on the stocks.

• Liquidity: Almosteveryinvestor can redeem theirmutual funds at the prevailing NAV in the market to the fund itself or to the broker. Hence, there is such kind of lock-in period.

Further, apart from the above discussed advantages there are also some disadvantages that are need to be understood before investing in a particular mutual fund.Below discussed are some of the disadvantages of mutual funds:

• Costs despite Negative Returns:Investors need to pay sales charges, annual fees and other expenses (as may prescribe by the MF) regardless of how the MF performs. Further, the investors may also need to pay taxes depending upon the tenure of investment in mutual funds.

• Lack of Control: Investors typically cannot ascertain the exact make-up of a fund’s portfolio at any given time, nor can they directly influence which securities the fund manager buys and sells or the timing of those trades.

• Price Uncertainty: The mutual funds are traded at the NAV of each fund and stocks prices are constantly changing even second-to-second and therefore one can have a look at his portfolio investment at every moment. In contrast to Mutual Funds, the NAV may not be calculated for many hours. Therefore, Mutual Funds must calculate their NAV’s at least once in a day.

Different Types of mutual Funds

When it comes to investing, the investor normally have thousands of choices and before investing one should carefully analyze the risk and returns of the mutual funds.

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Following given below are the major categories of Mutual Funds

1. Money Market Mutual Funds

These funds carries the less risk as compared to the other instruments and stocks available for investment. Many market funds keep trying to maintain their NAV of the fund stable (say at Rs. 1 per fund) but it may fall below if the fund doesn’t perform well. Investor losses are rare but they are surely possible. Money market mutual funds generally pay dividends that represents short term interest rates, and in most of the cases the historical returns on the money market mutual funds are generally lower in contrast to bonds or either stock.

2. Bond Funds

Bonds funds generally carries the risk higher than the money market mutual fund this is due to the reason that they are based on the strategies aimed at producing higher yields. Since there are various types of bond funds and hence their risk & returns can vary dramatically. Following are some the risk associated with the bond fund are as follows:

• Credit Risk

The risk that defines the credibility of the firm (issuer of funds in the market) whether they would be able to pay their debts in future or not.

• Interest Risk

The risk that states that when the interest rates will go up, than the market value of the bond will go down.

• Prepayment Risk

The chance that a bond will be paid off early.

3. Stock Funds

The value of the stocks can rise or fall very quickly (dramatically) over the short term, but historically stocks have performed better over the long term that other types of investments such as government bonds, corporate bonds and other government securities. Following are the different types of stock funds:

• Growth Funds (Good for long term growth and provides long term capital gains)
• Income Funds (Pays regular dividends)
• Index Funds (aims to achieve the same return as of the market index)
• Sector Funds (Funds specialized in particular industry)

Classes of Funds

Mutual Funds offers more than one class of share such as Class A or Class B shares. Each class will invest in the same portfolio of investments having the same objectives and policies. Given below is the brief of the two classes of shares:

• Class A Shares

These types of funds typically imposes a front-end sales load but they tend to have a lower fees and annual expenses as compared to other mutual funds share classes. Before investing into the class A shares must inquire about the breakpoints.

• Class B Shares

These funds do not impose a front end sales load but they imposed a contingent differed sales load and annual fees and expenses.

• Class C Shares

Class C shares might have a fee, either a front-end or back-end sales load along-with the other annual expenses. They are generally not convertible to other class.

A BIG QUESTION – HOW FUNDS CAN EARN MONEY FOR YOU?

1. Dividend Payments: A fund earning the income in the form of dividend and interest on its securities in portfolio and then pays all its earnings it had earned in the form of dividend.
2. Capital Gains Distribution: The price of the securities owned by the fund may increase and hence when the sale is being made at such higher prices by the fund, then the fund earns the capital gains and at the end of the period most of the funds pays these capital gains.
3. Increased NAV: The higher the value of the NAV the higher will be the value of your portfolio.

IMPORTANT POINTS TO REMEMBER ABOUT MUTUAL FUNDS BEFORE INVESTING

• Mutual Funds are not guaranteed or insured by any agency or institution i.e. even if you invest through a bank and the fund carries a bank name, one can might lose money in mutual funds.

• Sometime, investments are being made in the mutual funds on the basis of the past performance of the instrument but I would suggest that don’t get dazzled by the past performance of the instrument although one should assess the volatility of the instrument before investing.

• Every mutual fund has some cost, so before going into investment, one should carefully compare the fees and the other tax structure.

You can start investing small and you can learn more and more about investment.  Yes, there are some risks but remember above things in post while investing. As mentioned by me between post, choose the best platform to invest like Fundsindia and enjoy hassle free investing !