Basic of Mutual Fund
What is a Mutual Fund?
Mutual fund is a mechanism for pooling the resources by issuing units to the investors
and investing funds in securities in accordance with objectives as disclosed in
Investments in securities are spread across a wide cross-section of industries and
sectors and thus the risk is reduced. Diversification reduces the risk because all
stocks may not move in the same direction in the same proportion at the same time.
Mutual fund issues units to the investors in accordance with quantum of money invested
by them. Investors of mutual funds are known as unitholders.
The profits or losses are shared by the investors in proportion to their investments.
The mutual funds normally come out with a number of schemes with different investment
objectives which are launched from time to time. A mutual fund is required to be
registered with Securities and Exchange Board of India (SEBI) which regulates securities
markets before it can collect funds from the public.
What are the Benefits of Investing in a Mutual Fund?
Small Investments: Mutual funds help you to reap the benefit of
returns by a portfolio spread across a wide spectrum of companies with small investments.
Such a spread would not have been possible without their assistance.
Professional Fund Management: Professionals having considerable
expertise, experience and resources manage the pool of money collected by a mutual
fund. They thoroughly analyse the markets and economy to pick good investment opportunities.
Spreading Risk: An investor with a limited amount of fund might
be able to to invest in only one or two stocks / bonds, thus increasing his or her
risk. However, a mutual fund will spread its risk by investing a number of sound
stocks or bonds. A fund normally invests in companies across a wide range of industries,
so the risk is diversified at the same time taking advantage of the position it
holds. Also in cases of liquidity crisis where stocks are sold at a distress, mutual
funds have the advantage of the redemption option at the NAVs.
Transparency and Interactivity: Mutual Funds regularly provide
investors with information on the value of their investments. Mutual Funds also
provide complete portfolio disclosure of the investments made by various schemes
and also the proportion invested in each asset type. Mutual Funds clearly layout
their investment strategy to the investor.
Liquidity: Closed ended funds have their units listed at the stock
exchange, thus they can be bought and sold at their market value. Over and above
this the units can be directly redeemed to the Mutual Fund as and when they announce
Choice: The large amount of Mutual Funds offer the investor a wide
variety to choose from. An investor can pick up a scheme depending upon his risk
/ return profile.
Regulations: All the mutual funds are registered with SEBI and
they function within the provisions of strict regulation designed to protect the
interests of the investor.
Concept - Mutual Fund Operation Flow Chart
What does a Mutual Fund do with investor's money?
Anybody with an investible surplus of as little as a few hundred rupees can invest
in mutual funds. The investors buy units of a fund that best suits their investment
objectives and future needs. A Mutual Fund invests the pool of money collected from
the investors in a range of securities comprising equities, debt, money market instruments
etc. after charging for the AMC fees. The income earned and the capital appreciation
realised by the scheme, are shared by the investors in same proportion as the number
of units owned by them.
How is investment in a Mutual Fund different from a Bank Deposit?
When you deposit money with the bank, the bank promises to pay you a certain rate
of interest for the period you specify. On the date of maturity, the bank is supposed
to return the principal amount and interest to you. Whereas, in a mutual fund, the
money you invest, is in turn invested by the manager, on your behalf, as per the
investment strategy specified for the scheme. The profit, if any, less expenses
of the manager, is reflected in the NAV or distributed as income. Likewise, loss,
if any, with the expenses, is to be borne by you.
What are the types of returns one can expect from the Mutual Fund?
Mutual Funds give returns in two ways - Capital Appreciation or Dividend Distribution.
Capital Appreciation: An increase in the value of the units of the fund is known
as capital appreciation. As the value of individual securities in the fund increases,
the fund's unit price increases. An investor can book a profit by selling the units
at prices higher than the price at which he bought the units. Dividend Distribution.
The profit earned by the fund is distributed among unit holders in the form of dividends.
Dividend distribution again is of two types. It can either be re-invested in the
fund or can be on paid to the investor.