Mutual Fund is a financial vehicle which consists of sum of money obtained from various types of investors who like to invest in securities comprising of money market instruments, stocks, bonds and other assets. Prospectus of mutual funds contains investment objectives to which portfolio of mutual funds are matched. Professional money managers operate mutual funds, who allocate fund's assets and in turn attempt for production of income or capital gains for the investors.
Each shareholder takes part proportionally in the losses or gains of the
mutual fund. The performance of the mutual funds, which invest in numerous
securities, is calculated by tracking the change in total market capitalization
of the fund.
Securities which are bought by a mutual fund company determine its
value. So, when a person buys a share or a unit of mutual fund, he/she is
buying its portfolio performance or a part of its portfolio value. Mutual funds
shares do not give any voting rights whereas in stock a person has voting
rights. Many different stocks represent a mutual fund. Net asset value per
share, which is also expressed as NAVPS, is used in reference to price of the
mutual fund share. NAVPS is derived from value of securities and amount of
shares which are outstanding. Outstanding shares are in the hold of
institutional investors, shareholders and company insiders.
More safer than owning a single stock- Consider an individual who buys
only a Maruti Suzuki stock before that company has a awful quarter. He/she will
lose a huge deal of value because all of his/her money is tied to one single
company whereas, the same investor buys mutual fund shares, he/she will only
lose some amount as Maruti Suzuki is a little part of that portfolio.
Mutual funds are categorized representing various kinds of securities
which are targeted for portfolios and the return types they seek.
· Equity Funds- Stock or Equity funds are
the largest category. This type of fund invests mainly in stocks as the name
suggests. According to size of companies they are classified as small cap, mid
cap or large cap. According to investment approach they are classified as
aggressive growth, value, income oriented and others.
· Fixed Income Funds- Fixed income mutual funds
focus on investments which pay a fixed rate of return like corporate bonds,
government bonds or any other debt instruments. This type of mutual fund is
likely to pay a higher return than money market instruments and certificates of
deposit but one cannot say that it is not risky.
· Index funds- These types of funds
have gained their popularity in last few years. Investment strategies of these
funds are based upon the belief which states that it is mostly expensive and
extremely hard to beat the stock market consistently.
· Balanced Funds- These types of funds do
investments in both bonds and stocks to reduce risk of contact to one asset
category to another. It can also be named as Asset Allocation fund.
· Money Market Funds- The money market comprises
of risk free (safe) short term tools of Debt, mainly government treasury bills.
Returns are minimal as compared to others but a person doesn’t lose the principal
amount.
· Income Funds- A person invests in
income funds when he/she needs a steady income. This type of fund invests
majorly in premium quality corporate debt. Audience of this type of fund
comprises of retirees and conservative investors.
Mutual Fund Plans
· Direct Mutual Funds- Mutual funds which
are bought from an AMC which is an asset management company by an investor is
known as direct mutual fund plan. In these types of mutual funds- agents,
intermediaries, brokers have no role. There is no distribution fee or
commission which in turn brings down expense ratio. There is no transaction
charge when you start the systematic investment plan. This is because money is
directly paid to mutual fund company. You need to select best direct mutual
funds by surfing the internet and proper research needs to be done before final
selection.
· Regular Mutual Funds- When the mutual fund is
bought from a advisor or distributor, broker, it is known as regular plan. In
this category, commission is paid to the middleman because they bring a new
investor for their plan. Commission will be added to expense ratio by AMC. So
this explains that regular plan is slightly expensive than a direct plan.
Direct Plan advantages over Regular plan
· Higher return on reinvestment and amount compounds which is paid as
commission or distribution in regular plans.
· Lower Expense Ratio
Mutual Funds Advantages
· Diversification- Diversification or
intermix of assets and investments within the portfolio for reducing risk is
the major advantage for investment in mutual funds.
· Economies of Scale- It also provides
economies of scale. Buying a mutual fund spares investor from various
commission charges which are needed for creation of a portfolio.
· Easy Access- They are highly liquid
investments because they may be bought or sold very easily. They are most
feasible relative to other investments.
· Professional Management- Professional
investment managers take care of research and trading for different investors.
A investor himself don't need to manage investments or pick stocks.
· Transparency- Fairness and accountability
to investors is ensured.
Mutual Funds Disadvantages
· Fluctuating Returns- Like any other investments,
which do not guarantee return, there is at all times possibility that the value
of mutual fund can depreciate.
· High Costs- Professional management
comes at a high cost. Mutual funds investors need to pay this cost whether
their fund has performed or not.
· Cash Drag- Money is pooled from lacs
of investors, which means putting of money in the fund and at the same time
withdrawing it. For withdrawals, a great amount of portfolios are kept in cash.
Having large amount of cash is great for liquidity but money is not doing
anything which explains that it is a great disadvantage.
· Taxes- When a portfolio manager is selling a
security, a tax is triggered which is known as capital gains tax. While
investing, investor should keep in mind regarding taxes because it affects
returns.
Despite
of some disadvantages, Mutual funds is still considered as one of the best
forms of investment in terms of returns because of its great diversification
and easy accessibility.
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