Mutual Funds Basics

A mutual fund is one of the most potent investment options. It provides a viable investment avenue for the entire range on investors, from the discerning millionaire to the humblest of the investors. Though this tool of investment conevenience has been around for many years, it has gained currency and popularity only in the recent past. Due to its inherent advantages, the mutual fund has become the darling of investors and markets alike. In India, we have seen a vibrant market evolve over the years, and hundreds, maybe, thousands of different funds are actively traded in specialized markets. The funds have become the primary movers and shakers of the market, with huge pools of money at their disposal.

Though the term “mutual fund” has become the part of popular lingo, yet very few people actually know the fundamentals of a mutual fund. This article is an attempt to explain the basics of a Mutual Fund, in as simple a way as it is possible. So, how is a mutual fund defined?  Put simply, a large number of small investors mutually pool their money into a common fund. The collective corpus is then used for investment in suitable opportunities. Why is the money pooled or collected? Simply because it is sometimes better to invest a substantial sum of money to get the most out of an investment. It may be out of reach of most but the biggest of investors. The mutual fund, therefore, combines the money from numerous investors to give them the benefit of such investments.

Chief Characteristics of a Mutual Fund:

The following are the chief characteristics or features of a mutual fund:

1) The fund forms a pool from the money collected from the various investors. This pool is then invested, and the profits (or losses) are shared in the ratio of the amount invested (minus any administrative fee).

2) The shares (or  units, as they are called) of a MF are not available in the secondary market, neither can they be purchased from another investor. They have to be purchased from the fund itself.

3) The units can be sold back to the fund (directly, or through a recognized broker). This is called redemption.

4) A separate legal entity (called the Asset Management Company, or the AMC), is formed to manage the investments.

Why Invest through a Mutual Fund?

When there are a range of options that are available to a potential investor, why should an investor park her hard-earned money with a mutual fund? In other words, what are the advantages of investing through a mutual fund? Well, the advantages of investing through a mutual fund can be briefly stated as:

1) Opportunity:

The MF provides an opportunity of investment to an investor, which might have not been available otherwise. For example, an investor in India will find it extremely difficult to directly invest in European markets. She can route her investment through a MF which invests in European markets.

2) Diversification:

Proper diversification is a basic tenet of a good investment. For a small investor, diversification is rather difficult since the corpus of funds is small. A mutual fund readily provides this opportunity.

3) Professional fund management:

The funds are managed by highly trained and professional fund managers, who bring a lot of knowledge and expertise to the table. In this way, their expertise is available even to the humblest of the investor.

4) Convenience:

This is an important factor, since a large number of people run away from investments simply because they find them cumbersome. An investment through a mutual fund is highly simple, convenient and easily monitored, without the need for significant technical knowledge.

5) Liquidity:

Again, a significant advantage of a MF is that the investments are very liquid. The units of the MF can be easily redeemed through the fund itself or an authorized broker. It does take much time or formalities to get this done.

6) Low Cost:

A very nominal amount can get you started on the road to succesful investments. This amount may be sometimes as small as Rs. 1000! The amount of other costs such as administrative fees is also very small.

7) Variety:

You can get access to a whole gamut of investment options which cater to your individual risk and return profile. For example, you can chose to invest in high growth, stock-based funds, or you can chose to be consercvative with bond funds or money market funds.

Here, it must be stressed that not all of the above advantages are exclusive to Mutual Funds alone. In fact, these davantages are the hallmarks of any good investment. Yet, one can safely say that with all these advantages, the mutual fund is one of the best investment options available to the investor in today’s markets.