Understanding Mutual Funds

Understanding Mutual Funds - Blog by Fintock

A mutual fund (just like equity and bonds) is another kind of investment instrument. To put it plainly, it is a collection of stocks and/or bonds managed by professionals who are part of an asset management company (the company operating the fund). Or you can look at it as a sort of a company which pools in money from a number of people (potential investors like you) and then invests the sum in various other investment schemes like equity,bonds etc.

The nitty-gritty…

Each investor owns units, which represent a portion of the holdings of the fund that they own. The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV. Think of NAV as: what share price is to a stock, NAV is to a mutual fund. But rather than changing throughout the day it gets updated when trading closes since it is calculated as the total value of all assets/securities fund is holding per unit share of the fund. All the expenses and fees charged by the company on the other hand constitute the expense ratio.These include brokerage charges,management fees,entry and exit loads (what you have to pay while joining and exiting the fund resp.),etc. This is what you will have to pay extra apart from your investment amount to the fund company. These expenses are also regulated by the SEBI which has set different limits on different types of funds, a topic for future discussion so stay tuned :). 

Why bother??

The reason why mutual funds in recent years have become so popular (and why you keep hearing that phrase mutual funds sahi hai) is that the risk of equity is already minimised in mutual funds as they maintain a diverse investing portfolio.Now you might ask, why is that so? Imagine a scenario where one person invests some amount in the stocks of a company X directly and another person invests the same amount of money in a mutual fund. Now if for some reason your company X’s stock doesn’t do well or results in a loss, you would have lost all the money whereas in a mutual fund a potential loss in one company holding might be hedged/recovered by gains in other holdings of your fund.This is especially useful for individuals who simply just do not have the time to analyse each stock rigorously. 

 But unlike stocks, mutual funds do not give its holders any voting rights. Each person holds a share of the fund which represents investments in different stocks or other securities instead of just one holding.

The not so good stuff

There are some compromises though, in trying to minimise risk you have to give up control. As you can see, unlike other investments, you have no control over where your money is being put; it’s all down to the fund managers and what they feel is best. Moreover the performance of a fund is dependent on a variety of factors. And since a lot of funds have rookie investors onboard, a lot of them back out as soon as they see the market going down. This leaves the managers in a helpless position, having to sell holdings at a loss when they could have been going on a treasure hunt for stocks instead.

 So…How can I?

Now there are two basic ways you can go about investing in mutual funds: either go all in and invest all your money in one go (lump sum) or you can choose to invest a fixed small amount periodically (SIP or Systematic Investment Plan). Generally an SIP is considered an easier option especially for equity funds but even if you do choose a lump sum scheme you should try and stagger your investments over the whole year to beat volatility and minimise risk. This also instils financial discipline which as we saw in one of our previous blogs is a key attribute of an intelligent investor.

Choosing a fund involves taking into account all the different factors we have outlined above. It’s up to you to find the best possible combination that suits your investing profile. There are various platforms both online and offline where you can start investing in mutual funds. You can directly register yourself with AMCs like Axis mutual fund, Motilal Oswal Mutual Funds, UTI Mutual Funds or you can invest through aggregators like Coin by Zerodha. The hallmark of a great investor is how well he interprets and uses the knowledge available to him. And now we leave that task to you.

 

Ciao!

 


 

One Response

  1. […] we know what a mutual fund is already. If not, please hit this article here. So, we are talking about a common pool of funds which is managed by a fund manager. The funds are […]

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