All about Mutual Funds | How Mutual fund works?
There are different ways to make an investment. Many invest in the share market. But in order to trade in the stock market, one should have the knowledge about how it works, financial of the target company, technical knowledge and should actively look for opportunities to make profit.
In a layman language, mutual fund is where different people come together and make investment in bonds, stocks and other money market instruments with the help of a professional. The return on investment from mutual fund depends on the type of investment made
Points covered in this article are
What are Mutual Funds?
Features of Mutual funds
Types of Mutual funds
How does a mutual fund work?
Benefits of mutual fund investment
Mutual fund fees
1. What are Mutual Funds?
Mutual Fund is a pool of investment made by a group of investors on one security or combination of many. The value of mutual fund investment is not determined in terms of price as it is a combination of many stocks and bonds. So, the price of the mutual fund securities is called Net Assets Value (NAV). These funds are managed by a professional called 'Money Managers', who allocate the money into different securities and create return on investment
2. Features of Mutual funds
In recent times, people are becoming more and more aware of mutual funds and its benefits. Campaigns such as Mutual Fund Sahi hai were introduced to educate the public about it.
Features of Mutual Funds are
● Mutual Fund can be open ended or closed ended
● No fixed returns on investments as the market value of invested securities keeps fluctuating
● The NAV of a mutual fund does not fluctuate in business hours as it does in case of equity shares. Instead the NAV is determined at the end of each trading day
● Investment can be lump sum or on regular basis
● Various tax benefits can be availed
3. Types of Mutual funds
1. Money Market instruments
These are short term debt securities with low risk. The return on investment from these mutual funds are comparatively lower than others. Examples are treasury bills, commercial papers etc. These are considered as safest mutual fund investments that can be made
2. Equity funds
These are investments in equity stock. Risk of losing money is high in these funds. While investing in equity funds, one can choose from various types of equities many of which are classified by their size as small, mid and large.
3. Hybrid funds
It tries to achieve balance between Fixed income funds and equity funds. There is a balance between risk of losing money and high interest on investment. When either the equity or the debt market is crashing, hybrid funds maintains the balance reducing the loss incurred
4. How does mutual funds work?
There is a certain process to go through when investments are made till withdrawal. Every investor must know the steps to make an investment before making any
a. Investment in Mutual funds
● A fund manager helps invest money in various securities. The fund managers can also own funds. They determine whether the prices of securities will go up or down. They pool the money of different investors and invest it into securities
● Unlike in equity shares, investments are not made on the number of shares to be purchased but on the lump sum amount. The mutual fund company invests the money as per that day's NAV
● Investments are to be done in a diversified manner so that the portfolio is balanced and high returns can be earned
● Once investment is done, income can be earned by the way of dividends on funds, interest on bonds or capital gain/loss by selling the securities
b. Withdrawal from Mutual Funds
When a shareholder wants to withdraw his stocks or bonds from the mutual fund account, a withdrawal plan is to be made. Through this the investor earns funds on a periodic basis. The investor liquidates his portion of investment and withdraws cash periodically. It helps investors to enjoy return
5. Benefits of mutual fund investment
● As mentioned before, mutual funds allow investment in various securities at once making the investments diversified. This allows to balance the risk factor involved in dealing with securities
● The biggest advantage of mutual fund investment is the professional fund manager. The investor need not choose which stocks to invest in. All the decisions about investment is taken by the fund manager itself
● As different securities are traded together as a pool, the cost of trading is very low compared to individual stock transactions in the stock market
● Dealing in mutual funds is easy and feasible. This makes mutual funds highly liquid investment
6. Mutual Fund fees
As the fund manager deals with a large chunk of money on behalf of the investor, there is a lot of knowledge, expertise and effort that is needed. So, the mutual fund companies charge an amount approved under SEBI guidelines. There are different types of fees charged such as one-time fees, entry fees and exit fees
● One-time fee is charged during initial transactions as a contract between the investor and mutual fund company
● Entry fees is charged either before making a purchase or sometimes after the purchase is made
● Exit fees are charged when the investor wants to redeem the amount invested. This is charged to set a period of time as a lock-in period. If withdrawal is done after the lock-in period, exit load are not charged
Mutual funds are relatively easier to invest in than stock market investments because the investor need not actively participate in making the investments. But many people avoid mutual fund investment because of low income generation
Frequently Asked Questions
1. What is NAV?
NAV or Net Assets Value is market value of the securities held by the scheme. Market value of mutual fund scheme changes on daily basis
2. Who invests in mutual funds securities?
An Asset management company pools money from different investors and the fund manager appointed by the company deals with the investments and makes decisions about where the investments is to be made
3. What is SIP?
Systematic Investment Plan is the investment made on a periodic or regular basis rather than lump sum amount. It helps to analyze the NAV and make investments when there is high rate of return