Mutual Fund Series-I

There are number of investment options available in market today, mostly they all confuse investors instead of helping them. Right from traditional insurance to risky and volatile stocks, fixed deposit, post office savings deposit schemes, debentures (this alone has so many forms) and so on and so forth.

So how one can decide where to put his hard earned money?

Investment decision of individual depends on many factors. One should have fair knowledge of product beforehand he has decided to invest in that one. In this post we are going to discuss one popular form of investment that is Mutual funds.

What is a Mutual fund:

In simple terms mutual fund is an investment vehicle where many investors with similar interest come together and pool their money for a common investment objective. Then this fund is managed by professionals on their behalf. But this definition is very general and over-simplified in nature. Next one is a bit technical.

A mutual fund is a company that brings together money from many people and invests it in stocks, bonds, or other securities. (The combined holdings of stocks, bonds, or other securities and assets the fund owns are known as its portfolio.) Each investor owns units, which represent a part of these holdings.

Advantages of Mutual Fund investing-

Portfolio Diversification: Mutual funds invest in different kind of instruments viz. stocks, bonds, money market instrument etc. investment in such a wide variety of instruments provides diversification which may not be case in a normal investment.

Suppose as an investor you think ONGC, ACC, Infosys, Wipro or RIL share quite rewarding. These shares are currently trading between 1000 Rs. to 2500 Rs. So how many retail investors can buy these shares and what happens if prices go down after investing in them?

Suppose one is willing to invest 5000 Rs. in that case he will not able to invest in blue-chip companies share without taking high risk. Mutual fund comes handy at this time. You invest in any scheme that invests in large cap and your money will be invested in these large cap companies.

Professional Management: one of the main reasons behind existence of Mutual fund is lack of time and expertise which is not available for common investors. In a mutual fund, your money is managed by professionals who have good understanding of market. This professionally managed fund hence provides better return to investors.

Reduction of Risk: Diversification is a key characteristic of mutual funds. Diversification reduces risk.

Transaction Costs and Taxes: Investing in stock market have transaction cost. Whenever you buy or sell some stock you have to primarily pay brokerage charges. In case of mutual funds generally you are required to pay two kind of fee; entry and exit load. Mutual fund also provides tax benefit for some particular schemes.

Liquidity and Convenience: Mutual funds are highly liquid and marketable. Open ended funds can be redeemed right back to issuing AMC. Close ended funds are traded in secondary market.

Disadvantage of mutual fund investing:

Cost: There are two types of cost which is associated with mutual funds; one is usual entry and exit charges other is charges to cover expenses of fund. Sometime times these cost overweight returns.

Fluctuating returns: Over the time mutual funds have started to build portfolio in such a way that there returns are highly correlated with market. This results in returns that largely vary with market. Returns of mutual funds so fluctuates some times like market.

No guaranteed return: there is no guarantee that a scheme will provide you your expected return.

In next post: History, how mutual funds works, Structure, Types of Scheme