What is Mutual fund?
Mutual fund is basically a pool of money of its investors for structured investment in Stocks, Bonds, Govt. securities, Debt fund and other assets.
- These are operated by professional team who decide the allocation of fund assets to generate revenue for its investors. It is structured in a way to match the objectives of investments as stated in its prospectus. Its CEO is referred to as Fund manager/advisor.
- Mutual funds allows small and medium investors who lack professional knowledge in money market and hence got professional expertise to enhance return on their investments.
- They generally invests in a large number of securities to have a diversified portfolio and usually a single mutual fund holds hundreds of different securities.
Mutual fund value
The mutual fund value is dependent upon the value of stock/assets in its bag. So is it called Net Asset Value (NAV).
So it means investment in mutual funds is somewhat different from investment in stocks.
Types of Returns from Mutual Fund
The mutual fund company generally receives dividend from stocks it has investment into and interest from bond/debt funds which it holds. The same is distributed to its investors with a choice to either receive the amount in bank or to reinvest the earnings.
As mutual funds too keep selling and buying securities, they have capital gain in case they sell a security with high value which was purchased at lower value, then these earnings are passed to investors.
If the price of securities held by Mutual fund rises but he is not selling the securities then the NAV of mutual fund will rise and you can sell the fund at higher prices in market.
Advantages of Mutual Funds
It means mixing of investments and assets to reduce risk with enhanced returns with allocation to different industries, products with varying maturity period. As mutual funds owns hundreds of assets they offer better diversification which is not practically possible for a single investor to build such portfolio with such small amount.
They can easily be traded on exchanges using you’re Demat accounts making them really accessible. Now a days even some wallets give options to invest into mutual funds readily accessible 24X7 through their mobile apps example: PAYTM Money, Zerodha Kite etc.
As already discussed above the primary benefits is they have professional team to decide and manage investments. Investors lacking trading time, careful research, knowledge and expertise to manage their portfolios.
Economies of Scale
As mutual fund buys and sells large amount of securities at a time, the transaction charges/cost are lower than what individual investor use to pay.
Mutual fund have to follow regulatory instructions and so ensures accountability and transparency.
However, there are some cons/disadvantages too involved with Mutual Funds.
Disadvantages of Mutual Funds
Fluctuations in Return
Unlike a fixed income guaranteed investments like fixed deposits, mutual funds are subject to market risks and fluctuations. There is no guarantee of performance of any fund.
Parked Pool of Cash
As there are a lots of investors both small & medium ones are involved, everyday someone pool in or withdraw money from these Mutual funds and to accommodate these withdrawals, mutual fund needs to park a big amount of money idle for this need, on which no earning is generated.
As already discussed there is a professional team involved to manage portfolio of a mutual fund and so to engage and build such a professional team it have its own cost. The cost directly reduces the income generated by the fund. Online website management to E mail statement everything involves a cost and same is passed on to customers.
Too much complexity is not good every time, it may leads to result that may reach to worst. Engaging in fund without checking its Debt and equity mixture or in which funds/segments it is investing. For example : A renowned mutual fund has exposure of around 8% stake in a big company the stock price dropped from Rs. 287 to Rs. 47, now the MF portfolio manager has himself written a letter to investors that it was a mistake to invest in that particular company which leads to its capital erosion & investors have to bear a lots of loss
(To get this case history of this renowned company and mutual fund please leave a comment below and we will share the link separately with you for case study)
Selection of Funds
Unlike stocks, mutual funds so not shows P/E Ratio, Earning per Share, Sales data or any other important data. An apple to apple comparison between various mutual funds can be very difficult for small investors due to there diversification and different objectives.
Mutual fund fees
Usually the mutual fund operating and transaction fees varies from 1 – 3%. The fee is generally called ‘the load’ of a mutual fund. Front end Load is charged buying a fund and Back end Load are charged while selling a fund.
Some mutual funds also carries fees and penalties at earlier withdrawal before Lock in period.
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