Mutual Funds

For beginners, a Mutual Fund is an organisation where individual investors pool in their savings and channel them directly into the financial markets. As simple as this may seem, it yields a variety of investment options, ranging from government bonds to technology stocks.  Investing in the stock markets is not an easy task, especially if you don’t have the time to go about identifying, researching and monitoring investments. Investors with limited investment means need to look out for professional help and advice. This is exactly where mutual funds come in.  A mutual fund is like a place where investors with similar financial goals pool in their money, hire a professional manager to invest that money and monitor the investments.   A mutual fund is, thus, an organised, institutionalised, regulated means of channelling an individual’s money.  It is a pool of money that is managed on behalf of investors by a professional money management firm. The firm uses the money to buy stocks, bonds or other securities and an investor is issued units in return, determining the quantum of his investment in the fund. Each investor then shares proportionately in the funds, income (dividends or interest) and also in the capital appreciation or depreciation of the investments made by the firm that is reflected in the Net Asset Value (NAV) of his units.

The NAV represents the worth of your investment in the fund which is nothing other than the total value of the fund at any point divided by the number of units issued by the fund.   When you buy units, you pay the current NAV per share plus any fee the fund levies at the time of purchase. At the time of selling units, the fund pays the NAV minus any fee the fund levies at the time of redemption.

In return for managing the money, the fund charges fees based on the value of the fund’s assets. The fund manager, also called an investment advisor, directs the fund’s investments according to the fund’s objective, such as long-term growth, high current income, or stability of principal. Depending on its objective, a fund may invest in shares, bonds, and other investments or keep money in cash in various proportions.

To raise money, mutual funds issue a prospectus, written in a dense legal and financial language. If you can get through it, you will learn about the fund’s investment policies, objectives, risks, how well it has done in the past and details about the fund managers, the experts in investing. It describes the investment “style” of the fund, but funds often change their style and strategy.

Merits Of Mutual Funds
Diversification: Buying a mutual fund unit is like holding shares in many different companies at the same time that most investors cannot afford to own on their own. This gives you diversification in your investment. By holding securities in many companies, a fund reduces the impact of losses in particular scrips.

Professional management: As mentioned earlier, few investors have the time or expertise to manage their personal investments every day, to investigate the thousands of securities available in the financial markets and to efficiently reinvest interest or dividend income. This is a highly skilled job that professional money managers are dedicated to do. But individual investors cannot obtain the services of such managers. They can get it through mutual funds, which spend crores of rupees on stock pickers and on developing detailed research on various securities to decide the best investment options.

Affordability: You can buy mutual fund units with a small amount of money, for e.g., Rs 5,000 for initial purchase, and take advantage of diversification and professional management.

Liquidity: Just as you can sell your shares any time, a mutual fund investment can be sold and converted into cash whenever you want to, on any business day. Some funds can be sold in the open market, where another investor will come to buy, while some funds have to be sold back to the fund company.

Convenience: Investing in mutual funds is easy. You can buy units by mail, telephone or the Internet. You can plan automatic investments into a fund from your bank account, or you can arrange automatic transfers from a fund to your bank account to meet expenses at a pre-determined rate. With your own portfolio of investments, you would have to keep your own records of purchases, sales, dividends, interest, short-term and long-term gains and losses. None of this is needed for your mutual funds investment.

Flexibility: Most fund companies have a variety of mutual funds (e.g., money market, fixed-income, growth, balanced and international funds) and allow you to switch between funds within their ‘fund family’ at little or no charge. This can help you to balance your portfolio as per your personal needs or market conditions.

The Other Side
Not so professional: The record of “professional” management by funds is often not something to be enthusiastic about. There are studies to prove that the average mutual fund manager makes stock investments that are no better than the non-professional, random stock picking that a rank amateur would do. Of course, mutual funds charge you annual fees that are not amateurish at all!

Beyond your control: Unlike picking your own stocks or bonds, buying a mutual fund puts you in the back seat of your car, at the mercy of the driver. It may be a good ride but you must know that if the driver makes mistakes, you are helpless.

Riskier: Mutual funds are regulated by the Securities and Exchange Board of India, which requires them to disclose a plethora of information. But unlike bank deposits or some fixed income instruments, mutual fund units are not insured or guaranteed by any government agency. Indeed, the mutual fund units fluctuate widely in value, even if the fund is invested in bonds.

Costs: Mutual funds are more expensive, although the industry’s claims are quite the opposite. Now that stockbrokers charge so little by way of commission, buying stocks directly is much cheaper than paying funds to buy them. Besides, sales commissions and high operating expenses at some fund companies may reduce your investment returns.

So if you thought being a part of the market boom was just not possible if you were not a part of the hard-core financial world, trying out Mutual Funds as an alternative could definitely work for you.