Introduction of Mutual Fund
Mutual Fund is an establishment that pools money from various investors and invests that money into financial instruments and securities like stocks, bonds, debt instruments, etc. The combination of all these investments together is called a portfolio. Investors who invest money in a mutual fund will get shares representing ownership in the portfolio proportionate to their investment.
Explanation
A Mutual fund is a professionally managed fund. It pools money from investors to purchase securities. Mutual fund investment is open for both retail investors and institutional investors. The key benefits of investing in mutual funds are its diversification, it is managed by professionals,and investments are done after proper research and it is also a liquid investment. The fund managers charge some management fees which comes as an additional expense when compared to independent investment.
Features of Mutual Fund
- A Mutual fund is managed by professionals. The fund managers do complete research and analysis before investing in any securities or instruments. On investment, they monitor the portfolio and its performance.
- A Mutual fund is known for its diversification. It invests in various securities and instruments in a range of companies and different industries. By diversification, the risk in the portfolio is reduced.
- Mutual fund shares are available at a relatively lower price compared to independent investment in equities as the portfolio as a total is issued in multiple units to investors.
- A Mutual fund is a liquid investment, it can be easily redeemed at any time and the shares will be redeemed at the current net asset value (NAV) with some redemption fees.
How Does It Work?
Mutual funds are managed by portfolio managers. Investors who want to invest in the capital market and other securities and if they lack the knowledge and skillset they choose to invest in mutual funds as it is managed by professionals who have experience in investment, and they do proper research before investing. Investors get the shares of mutual funds and it gives good returns to investors in the form of capital appreciation and income yield.
Types of Mutual Fund
Following are the types are given below:
1. Money Market Funds
Money market funds invest money in money market instruments. It invests in short-term fixed-income securities. Investors predominantly choose money market funds as a substitute for bank deposits, but it is not as secure as bank deposits as the government does not guarantee these investments.
2. Bonds Funds
Bond funds invest in fixed income securities or debt instruments. This fund is mainly to generate fixed income for the investors and the investment money is also secured as it is a low-risk investment. There are various bond funds that differ from the issuer of the bond (Government, Corporate, Municipal, etc.) and time-period (Short-term, Intermediate, and long-term).
3. Stocks or Equity Funds
Stock or equity funds are an investment in the shares of the corporates in the capital market. The stock funds are also diversified as the portfolio predominantly consists of shares from different companies, industries, growth stocks, income stocks, strong valuation companies, high market cap companies, etc. This fund has more risk compared to other funds and the value of mutual fund shares is subject to market risk and volatility.
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4. Hybrid Funds
Hybrid funds invest both in stocks and bonds. They balance the risk and returns by investing in different securities. It is structured as funds of funds as hybrid funds invest in other mutual funds that invest in securities. The ideal proportion of equity and bond is fixed in order to get good returns and also to manage the risk of the portfolio.
How to Make Money from the Mutual Fund?
There are various funds in mutual funds. An Investor needs to choose the right fund based on their return expectation and risk appetite. They are many portfolio managers and they have a track record of their investments and the returns generated. Investors can compare and choose the fund manager who meets their expectations.
Structures of Mutual Fund
The primary structures of mutual funds are as follows.
1. Open-End Funds
Open-end mutual funds are funds that are willing to buy back (Redeem) their shares from investors based on the net asset value (NAV) computed on the day of redemption based on the market price of the securities in the portfolio. Open-end mutual funds shares are sold on every business day to investors valued based on the net asset value.
2. Unit Investment Trusts (UIT)
Unit investment trusts are issued at the time when trust is created, and it is issued for a specific period to the investors. It also gives the option to the investors to redeem the shares at any time else investors can redeem the shares upon termination of the trust. This fund is not managed by any portfolio manager as the securities in the portfolio and the time of holding is pre-determined at the time of the creation of the trust.
3. Closed-End Funds
Closed-end funds are issued to investors only once at the time of the creation of funds through an Initial public offering (IPO) and then it is listed in the stock exchange. An Investor can exit the fund only by selling the shares in the market and they cannot sell it back to the mutual fund. The IPO through which the fund shares are issued can list the shares either at a premium (i.e.) more than the NAV or at discount (i.e.) less than NAV.
4. Exchange-Traded Funds (ETF)
Exchange-traded funds (ETF) is a combination of both open-end and closed-end funds They are structured like open-end funds, but it is also traded in the stock exchange. The arbitrage mechanism is used to keep the trading price of ETF close to the net asset value.
Advantages
Some of the advantages are given below:
- It has a diversified portfolio by holding various securities in various companies and industries and diversification reduces the risk of the portfolio.
- It offers high liquidity to investors as they can redeem the mutual fund shares at any time for their net asset value.
- It is managed by professionals who possess the required knowledge and skillset in investments, and they supervise the performance of the portfolio.
- The mutual fund shares are priced at a lower value and it can be easily purchased by even small investors who cannot directly invest in shares and equities.
- It has its own regulations and it is also regulated by governmental institutions.
- It operates with complete transparency to investors and all the information is reported to investors.
Disadvantages
Some of the disadvantages are given below:
- It charges management fees; It is an additional expense to investors.
- Investors cannot control the investment plan of the portfolio managers as they don’t have the option to decide on the investments.
- Mutual funds are also subject to market risk and it varies from fund to fund. The growth and income yield from investments are not predictable.
- It is also a fixed plan of investment and it cannot be customized according to investor needs.
Conclusion
A Mutual fund is a good investment for small investors who cannot directly invest in securities in the capital market and it is also useful for investors who lack the experience and knowledge of investment and it is not possible to do complete research like how professionals do. Investors can invest either in SIP plans or lump sum plans. SIP plans are a good regular investment and the investors can enjoy both value appreciation of investment as well as income generated from funds.
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