A Mutual Fund is a collective investment product formed to raise money from many individuals and invest it according to pre-specified investment objectives. The benefits of a mutual fund scheme are shared among all the investors in proportion to their investments.
Mutual funds are the most popular among individual investors. This is because it gives the benefit of an instant diversification of investments.
Mutual funds invest in investment products like equity, bond, money-market securities, real estate, alternate asset classes, commodities, etc.
How does a Mutual Fund Work?
A mutual fund is an entity incorporated in the form of a Trust. It offers different schemes with predefined investment objectives. A mutual fund scheme accepts money from investors and then employs a fund manager to invest that money according to the rules developed for that particular scheme. For instance, if you put your money into a mutual fund that is invested in big, multi-national companies, the fund manager would take your money and the money from all of the other investors in the mutual fund and buy stocks in large-cap companies. In this process, an investment fund is created, and shares of that fund are issued to the public. These shares are termed mutual fund units.
When you put money into a mutual fund, you buy units of that scheme. As the entire fund increases in value, your units also increase in value. As the entire fund decreases in value, your units also decrease.
Different Types of Mutual Funds
Investors today have choices when investing in mutual funds.
Understanding your individual financial goals and risk tolerance—either on your own or with the help of your Financial Advisor—is the first step in reaching your long-term financial goals. This will help you to begin narrowing your choices.
Mutual funds fit into three main categories—money market funds, bond funds, and stock funds (also called “equity” funds). Each category has unique features, risks, and rewards. In general, the higher the potential return, the higher the potential risk of loss.
Based on investment, mutual fund schemes could be classified into different categories. Each mutual fund scheme is different and should be selected after careful reading the scheme objective and matching it with financial goals.
A broad classification of Mutual Fund Schemes
- Money Market Funds
- Income Funds
- Growth Funds
- Equity Funds
- Sector Funds
- Equity Income Funds
- Index Funds
- Balanced Funds
- Exchange Traded Funds
Buying and Selling Mutual Funds Units
Mutual fund units could be purchased and sold on any business day. Mutual funds are priced once daily at a time specified in the prospectus, usually after 3;30 PM of a trading day which is close to the trading time of the equity segment on an exchange like NSE and BSE. When your purchase or sell order is received before the established cut-off time, your transaction will receive the price calculated for that day.
Purchasing Mutual Fund Units
When you buy shares, you pay the current NAV per share plus any fee the fund may assess at the time of purchase, such as a sales charge or other type of purchase fee.
Selling Mutual Fund Units
When you sell your shares, the fund will pay you the current NAV minus any fee the fund assesses at the time of redemption, such as a deferred or exit load or redemption fee.
What is the Net Asset Value (NAV) of a scheme?
The performance of a particular mutual fund scheme is denoted by Net Asset Value (NAV). Mutual funds invest the money collected from investors in securities markets. Since the market value of securities changes every day, the NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of scheme units on any particular date.
For example, if the market value of securities of a mutual fund scheme is INR 50 Crore and the mutual fund has issued one crore units to the investors, then the NAV per unit of the fund would be Rs 50/- per unit (i.e., Rs 5 Crore / 1 Crore). NAV is required to be disclosed by the mutual funds daily. The NAV per unit of all mutual fund schemes has to be updated on AMFI‟s website and the Mutual Funds website by 9 p.m. of the same day. Fund of Funds is allowed time till 10 a.m. the following business day to update the information.
Benefits of Investing in Mutual Funds
Investing in mutual funds has many benefits for individual investors. Some of the key benefits are: –
- Professional management
- Diversification
- Liquidity
- Ease of investment
- Variety in investing
- Cost Averaging
- Transparency
Conclusion: Mutual Fund for All Investors
There are two significant reasons why most people around the globe are afraid to make investment decisions on their own. One is the lack of time to study the pros and cons of different investment opportunities, and the other is the lack of financial know-how. Apart from that, some financial markets have a steep entry barrier, which prevents a small ticket investor from participating in the growth of that sector.
The investment needs of different investors may not be the same. While some may settle for the safety of capital, others may chase returns. Others want their money to grow steadily, while some may want to save for retirement or a child’s education. The need and objectives of the investors are genuinely diverse, and one financial product can’t fulfill all of them. The emergence of mutual funds in the past decade as a popular investment product broadly serves all categories of investors through the plethora of schemes it offers. The benefits of mutual funds far outweigh their shortcomings and have thus gained widespread acceptance.
