Mutual Fund Basics
1. What is Mutual Fund?
A mutual fund is a form of collective investment that pools money from investors and invests the money in stocks, bonds, short-term money-market instruments, and/or other securities. The fund manager trades the fund's underlying securities, realizing a gain or loss, and collects the dividend or interest income. The investment proceeds are then passed on to the individual investors.
The rationale behind a mutual fund is that there are large numbers of investors who lack the time and or the skills to manage their money. Hence professional fund managers, acting on behalf of the Mutual Fund, manage the investments (investor's money) for their benefit in return for a management fee. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
2. Why it is better to invest through mutual funds rather than investing individually?
Making investment requires a lot of knowledge and expertise on the area of investment. Some of the basic requirements to invest in capital markets are as follows:
a. Up to date financial data and other material information regarding the investment
b. Financial knowledge and expertise to analyze financial statements
c. Expertise to analyze other material information
d. Sufficient time to analyze financial statements and material information
e. Financial tools that is required for analysis of the data
f. Skill for interpretation of data and information and link it to value investment for reaching fair pricing
g. Sufficient fund to make diversified investment
h. Continuous monitoring of investment performance and make changes in the allocation of invested funds etc.
In most cases, individuals lack these basic requirements. A very small mistake in analysis may cause heavy loss. Even those institutions that provide financial market services but not the investment management services may not be able to arrange for regular analysis and monitoring of investment due to the priority towards their core business. Therefore, mutual fund is the best alternative for individuals as well as for many institutions to invest in capital markets.
In case of naïve investors who lack all the above requirements and do not have sufficient amount for diversifying investment, Mutual Fund is the only alternative to invest in capital markets.
3. What are the benefits of investing in mutual funds to investors?
Affordability: Mutual funds allow the investors to start with small investments. For example, if an investor wants to buy a portfolio of blue chips of modest size, s/he should have at least one Lakh rupees. A mutual fund gives that investor the same portfolio for a smaller sum of money. A mutual fund can do that because it sells the units of the mutual fund schemes even for a very small sum of money and creates large corpus from such small sums and invest it to create the same portfolio.
Professional management: The major advantage of investing in a mutual fund to the investors is that they get a professional money manager for a small fee. The investor can leave the investment decisions to the fund manager and only has to monitor the performance of the fund at regular intervals.
Diversification: Considered the essential tool in risk management, mutual fund makes it possible for even small investors to diversify their portfolio. A mutual fund can effectively diversify its portfolio because of the large corpus. However, a small investor cannot have a well-diversified portfolio because it calls for large investment.
Convenience: Mutual funds offer tailor-made solutions like systematic investment plans and systematic withdrawal plans, which is very convenient to investors. Also, investors do not have to worry about the investment decisions or deal with their brokerage or depository, etc. for buying or selling of securities. Mutual funds also offer specialized schemes like retirement plan, children's plan, industry specific schemes, etc. to suit personal preferences of investors. These schemes also help small investors with asset allocation of their corpus. It also saves a lot of paper work.
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