What is a mutual fund?
Basically, a mutual fund is a trust. It pools money from like-minded unit holders/investors and invests the same a diversified portfolio of securities through various schemes that address different needs of investors. The corpus so collected is invested by the Asset Management Company (AMC) in different types of securities that may include equity shares, debentures, convertibles, bonds, money market instruments or other securities, based on the investment objective of a particular scheme. Such an objective is clearly laid down in the offer document of that scheme. The mutual fund adds value to the investment in two ways: income earned and any capital appreciation realised through sale. This is shared by unit holders in proportion to the number of units they own. Our tagline ‘Beyond The Obvious’ well expresses our mission of, exploring & thinking on new ways, thinking beyond the defined models, providing a well-defined long term plan to ensure smooth movement of our clients towards their financial freedom.
What is an Asset Management Company?
An AMC is involved in the daily administration of the mutual fund and also acts as the investment manager for the fund. An AMC is promoted by a sponsor which usually is a reputed corporate entity. An AMC typically has three departments:
What are the different types of mutual fund schemes?
Mutual fund schemes can be classified as follows:
What is the difference between an open ended and close ended scheme?
Open-ended schemes can issue and redeem units any time during the life of the scheme. Closed-ended funds cannot issue new units except through a bonus or rights issue. Hence, unit capital of open-ended funds can fluctuate daily but that is not the case with closed-ended schemes. Further, new investors to an open-ended fund can join the scheme by directly applying to the mutual fund at applicable prevailing NAV. In the case of close-ended schemes, new investors can buy units only from the secondary market.
What is the difference between an open ended and close ended scheme?
Open-ended schemes can issue and redeem units any time during the life of the scheme. Closed-ended funds cannot issue new units except through a bonus or rights issue. Hence, unit capital of open-ended funds can fluctuate daily but that is not the case with closed-ended schemes. Further, new investors to an open-ended fund can join the scheme by directly applying to the mutual fund at applicable prevailing NAV. In the case of close-ended schemes, new investors can buy units only from the secondary market.
What is a Prospectus or Offer Document?
It is a document which an open-end fund or newly issued closed-ended fund is required to provide to investors. Funds say that investors should read it carefully before investing money. A prospectus typically contains the following:
What is the Net Asset Value (NAV)?
The NAV is the market value of the fund's underlying securities. It is calculated at the end of the trading day. Any open-ended scheme buys or sells the order received on that day based on the NAV calculated at the end of that day. The NAV per unit is calculated as follows:
| NAV | = | Market Value of Assets - Liabilities |
| Units Outstanding |
What are Dividends?
A mutual fund scheme may receive dividend or interest income from the securities it owns. The scheme in turn pays this income to its investors/unit holders. Most open-ended funds offer an option to purchase additional units with the dividends. Dividends are often made monthly or quarterly, though most schemes declare dividend distributions on a yearly basis.
Are investments in mutual fund units safe?
It is well known that no stock market related investments can be termed safe with certainty as they inherently carry an element of risk. However, different funds have different risk profiles, which are stated in their respective investment objectives. Funds which categorize themselves as low risk, invest generally in debt which is less risky than equity. However, it is pertinent to note that as mutual funds utilize the services of expert fund managers, they are always safer than direct investment in the stock markets.
What are the Risks in a mutual fund?
Equity Funds are open to market risk i.e. there is a possibility that the price of the stocks in which the fund has invested may decrease. Of course, the prices may also go up, making it possible for the fund to earn superior returns. Debts Funds are open to two main types of risks - Credit Risk and Interest Rate Risk. Credit Risk refers to the possibility that the company which has issued the bond or debenture in which the fund has invested may default on interest or on principal payments. Debt fund managers take care of this by investing in debt securities which have good credit rating. Interest Rate Risk refers to the possibility that the price of the bond in which the fund has invested may go down because of an increase in the interest rates in the economy. In general, it is useful to remember that this is a "see-saw" relationship - bond prices (and therefore the NAV) go up when interest rates drop and vice versa.
What are the benefits of a mutual fund?
Investing through mutual funds has a number of benefits.
Do mutual funds assure returns?
No. Returns in mutual fund investments are not assured.
How do you make money in a mutual fund?
There are two ways in which you can make money through a mutual fund investment. First, you can earn a dividend from the mutual fund scheme. Most debt funds declare dividends around once in six months in their Dividend Option. If you do not want the dividend, you can choose to be in the Cumulative Option. When a dividend is declared, the NAV of the units will fall, since dividend is paid out of the appreciation in the value of the unit.
Second, you can make a return by selling the mutual fund units at a price higher than that at which you bought them. This is called capital gain. On the other hand, if you sell the units at a price lower than your purchase price, you end up making a capital loss.
Please note that taxation of dividends and capital gains are treated differently.
Who should invest in mutual funds?
Mutual funds can meet the investment objectives of almost all types of investors. Younger investors who can take some risk while aiming for substantial growth of capital in the long term will find growth schemes (i.e. funds which invest in stocks) an ideal option.
Investors in the middle age can allocate their savings in balanced schemes (i.e. hybrid between equity & debt) and growth funds and achieve both income and capital growth.
Older investors who are risk-averse and prefer a steady income in the medium term can invest income schemes (i.e. funds which invest in debt instruments). Investors having regular income/savings can adopt the Systematic Investment Plan (SIP) route to invest on a regular basis.
As mutual fund schemes invest only in stock markets, are they suitable for small investors?
While mutual fund investments are meant for all types of investors, they are all the more suitable for small investors. The prime reason is that successful investments in stock markets require careful analysis which is not possible for a small investor. Mutual funds are usually equipped to carry out thorough analysis and can provide superior returns.
Disclaimer: The contents mentioned above are for informative purposes only and should not be considered as a substitute for specialized professional advice. Please take the guidance of an expert before acting upon any investment decision.