What is a Mutual Fund?
Mutual fund or group of mutual funds is an agglomeration of different types of financial instruments where, a group of likeminded individual investors invest their savings with an objective of safely investing their money in the stock market or other securities. Investments are done through a mutual fund financial intermediary known as Asset Management Company (AMC) to earn decent returns without having to go through the hassles and risks of direct investment. In AMC, stock market experts with their thorough understanding of the dynamics of the stock market prudently invest public money to earn decent returns on behalf of small investors. In this way the mutual funds generate good will and earn the confidence of the investors and improve their business standing.
Comparatively, mutual funds are less financially risky as they invest in diverse stocks because of the availability of large quantum of money there by maximizing returns and simultaneously reducing risk. On the other hand mutual funds are easy to buy compared to buying of shares and more cost effective than individually investing in stock market where you can only buy few selected shares and wait for returns.
Portfolio of investments by mutual funds
Diversification is the process of spreading investors’ money into various types of investments such as stocks, bonds, commodities and beyond. The diversity investment aspect brings down the stock markets associated risks to a great extent. Individually you need large money and complete understanding of the stock or the instrument and substantial time and when you channelize your money into mutual fund, you are quickly done in as the AMC of mutual fund trust would have already done that.
Different schemes of Mutual Funds
Innovation in investing has been the key for mutual fund managers and this led to various types of mutual fund instruments for investors to buy, depending on their overall feel and understanding of the stock market. For example, in a real estate boom, investor may think to buy units from the portfolio which has specialized in those investments. There are several varieties of mutual funds specialized in investing in different categories of stocks.
With respect to schemes, mutual funds offer open ended schemes where an investor can invest his money throughout the year. These types of schemes would not have any tenure and the investors can buy and sell these units at their NAVs (Net Asset Value).
The closed end schemes are offered like shares in initial public offering for a fixed duration and these instruments would have specified maturity period. These schemes would get listed in the stock exchange and they can be traded after listing. The market price of the closed end mutual fund scheme may vary from its NAV on account of demand – supply gap and other market factors. As per SEBI (Securities and Exchange Board of India) guide lines. The investors in these schemes are given at least one or two routes to exit their investment from the fund.
The interval schemes combine the features of close ended and open ended mutual fund schemes: they can be traded in the market at their market price and they can be redeemed at pre determined intervals at their net asset value.
Another way of categorizing the mutual funds is based on how they are managed. The fund that is actively managed looks into the stock market and invests the fund accruals accordingly. There is another category of fund called index fund. It follows major indexes of stock market and invests accordingly.
It is generally believed that only few mutual funds outperform the expectations. Between actively managed funds and index funds, it is noted that index funds record very sluggish growth.
Advantages and disadvantages of investing in mutual funds
The mutual funds draw their strength from the professional management of the fund, diversification within the given investment category and again across various types of investment avenues, the scale at which they transact business. On other hand, they provide easy liquidity and simple to invest and minimum investment levels are also very small allowing small investors to come forward to invest their money.
Sometimes professional management dynamism may not match the vagaries of the stock market leading to poor performance of the fund category. The entry and exit load charged by the AMC is their source income and it is generally hidden in the jargon. Dilution of investment makes it less risky and at the same time less profitable. Finally, the taxation aspects of individual investors are not taken in to consideration by the fund managers and there by affecting the profitability of the investor.
It can be said that among the various financial instruments and their risk matrix, mutual funds are treated as lower risk higher returns type investments. Mutual funds are best preferred for long term investment. Besides, there are some interesting categories of mutual funds like the one which invest only in environmentally compliant companies.