What is a Mutual Fund?

A mutual fund comprises a pool of funds collected from a large number of investors who invest in securities such as stocks, bonds, and short term money market instruments. The portfolio of a mutual fund is structured and maintained by fund managers. The mutual fund will have a fund manager who is responsible for investing the gathered money into specific securities (stocks or bonds). When you invest in a mutual fund, you are buying units or portions of the mutual fund and thus on making investment you becomes a shareholder or unit holder of the fund.

Features of a Mutual Fund

Trading in mutual funds is carried out under strict government regulations. In accordance with the Securities Act of 1933 and the Securities Exchange Act of 1934, all mutual funds must be registered with the US Securities and Exchange Commission (SEC). Disclosure of information about relevant details and the acquired securities are also legally essential.

Specific features of mutual funds include liquidity, transfer of money, purchase of units and high competition. Investment in mutual funds is highly liquid as funds are required to redeem shares daily. It permits transfer of money from one type of fund to another, but the exchange takes place within the same fund family. Units of mutual funds can either be purchased directly or through an investment professional, such as a broker or a financial planner.

Types of Mutual Funds

Mutual funds are classified on the basis of:

• Maturity period
  • Open-ended Funds
  • Close-ended Funs
• Investment objective
  • Growth/equity-oriented funds
  • Income/debt-oriented funs
  • Balanced funds
  • Gilt funds
  • Index funds

Benefits of a Mutual Fund

Mutual funds are considered as one of the best available investments as compare to others.

• They are very cost efficient and also easy to invest in, thus by pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. The cost of transaction in a mutual fund is divided among all the shareholders, which facilitates cost-effective diversification.
• But the biggest advantage to mutual funds is diversification, by minimizing risk & maximizing returns. Facilitates easy access of professionally-managed portfolios to small investors. Allows investors to instantly diversify into several sectors and reduce the risk profile of their portfolio.
• Enables investors to benefit from professional services like that of a fund manager.

Advantage and disadvantages of investing in mutual funds:

Before investments in mutual fund, one must be aware of the Pros and cons of investments in mutual fund.

Advantages:

• The basic advantage of funds is that, they are professional managed, by well qualified professional. Investors purchase mutual funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is comparatively considered to be less expensive way to make and monitor the investments.
• Diversification is another advantage. Purchasing units in a mutual fund instead of buying individual stocks or bonds, the investors risk is spread out and minimized up to certain extent. The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others.
• Mutual fund buy and sell large amounts of securities at a time, thus help to reducing transaction costs, and help to bring down the average cost of the unit for their investors.
• Just like an individual stock, mutual fund also allows liquidity to investor as it can be liquidated as and when they want.
• Investment in mutual fund is considered to be easy as compare to other available instruments in the market, and the minimum investment is also small.

Disadvantages:

• Some funds doesn’t perform in neither the market, as their management is not dynamic enough to explore the available opportunity in the market, thus many investors debate over whether or not the professionals are better or investor him self, for picking up stocks.
• The biggest source of income for AMC, is generally from the entry & exit load which they charge from an investors, at the time of purchase. The mutual fund industries are thus charging extra cost.
• Because funds have small holdings among different companies, high returns from a few investments often don’t make much difference on the overall return. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money.
• When making decisions about your money, fund managers don’t consider your personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is triggered, which affects how profitable the individual is from the sale. It might have been more advantageous for the individual to defer the capital gains liability.

How to monitor your investments?

Having made an investment in a mutual fund, you should monitor it to see whether its management and performance is in line with stated objectives and also whether its performance exceeds or lags your expectations. Unlike individual stocks and bonds, mutual fund reviews are required less frequently, once in a quarter should be sufficient.

A review of the fund’s performance should be carried out with the objective of holding or selling your investment in the mutual fund. You might need to sell your investment in a mutual fund in any of the following conditions:

• You change your investment plan: For example, as you grow older you might adopt a more conservative investment approach, pruning some of your riskier (equity-oriented) funds.

• A fund changes its strategy: A fund that alters its investment objective or approach might no longer fit your strategy.

• The fund’s poor results persist: If a fund regularly trails other funds that invest in similar securities, consider replacing it. The poor performance is more often than not a reflection on the relative expertise of the asset management company.

Each mutual fund has a specific stated objective:

The fund’s objective is laid out in the fund’s prospectus, which is the legal document that contains information about the fund, its history, its officers and its performance.

Some popular objectives of a mutual fund as follows:

• Equity (Growth): Invests only in stocks
• Debt (Income): Invests only in fixed-income securities
• Money Market: Invests in short-term money market instruments (including Government Securities)
• Balanced: Invests partly in stocks and partly in fixed-income securities, so as to maintain a ‘balance’ between risk and return.

Managed by an Asset Management Company (AMC)

The company that puts together a mutual fund is called an AMC. An AMC may have several mutual fund schemes with similar or varied investment objectives.

The AMC hires a professional money manager, who buys and sells securities in line with the fund’s stated objective.

All AMCs regulated by SEBI, Funds governed by Board of Directors

The Securities and Exchange Board of India (SEBI) mutual fund regulations require that the fund’s objectives are clearly spelt out in the prospectus.

In addition, every mutual fund has a board of directors that is supposed to represent the shareholders’ interests, rather than the AMC’s.

Types of returns

There are three ways, where the total returns provided by mutual funds can be enjoyed by investors:

• Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all income it receives over the year to fund owners in the form of a distribution.
• If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
• If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit. Funds will also usually give you a choice either to receive a cheque for distributions or to reinvest the earnings and get more shares.