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 Types
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.