Mutual Fund An Introduction
CONCEPT
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund:
Mutual Fund Operation Flow Chart
ORGANISATION OF A MUTUAL FUND
There are many entities involved and the diagram below illustrates the organizational set up of a mutual fund:
Organisation of a Mutual Fund
ADVANTAGES OF MUTUAL FUNDS
- Professional Management
- Diversification
- Convenient Administration
- Return Potential
- Low Costs
- Liquidity
- Transparency
- Flexibility
- Choice of schemes
- Tax benefits
- Well regulated
TYPES OF MUTUAL FUND SCHEMES
Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risk tolerance and return expectations etc. The table below gives an overview into the existing types of schemes in the Industry.
By Structure
- Open – Ended Schemes
- Close – Ended Schemes
- Interval Schemes
By Investment Objective
- Growth Schemes
- Income Schemes
- Balanced Schemes
- Money Market Schemes
Other Schemes
- Tax Saving Schemes
- Special Schemes
- Index Schemes
- Sector Specific Schemes
Mutual Fund FAQ
What is a Mutual Fund?
Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. Each scheme of a mutual fund can have different character and objectives. Mutual funds issue units to the investors, which represent an equitable right in the assets of the mutual fund.
What is the difference between an open ended and close ended scheme?
Open ended funds can issue and redeem units any time during the life of the scheme while close ended funds can not issue new units except in case of bonus or rights issue. Hence, unit capital of open ended funds can fluctuate on daily basis while that is not the case for close ended schemes. Other way of explaining the difference is that new investors can join the scheme by directly applying to the mutual fund at applicable net asset value related prices in case of open ended schemes while that is not the case in case of close ended schemes. New investors can buy the units from secondary market only.
How are mutual funds different from portfolio management schemes?
In case of mutual funds, the investments of different investors are pooled to form a common investible corpus and gain/loss to all investors during a given period are same for all investors while in case of portfolio management scheme, the investments of a particular investor remains identifiable to him. Here the gain or loss of all the investors will be different from each other.
What does Net Asset Value (NAV) of a scheme signify and what is the basis of its calculation?
Net asset value on a particular date reflects the realisable value that the investor will get for each unit that he his holding if the scheme is liquidated on that date. It is calculated by deducting all liabilities (except unit capital) of the fund from the realisable value of all assets and dividing by number of units outstanding.
Can I get fixed monthly income by investing in mutual fund units?
Yes, there are a number of mutual fund schemes which give you fixed monthly income. Further, you can also get monthly income by making a single investment in an open ended scheme and redeeming fix value of units at regular intervals.
What are the tax benefits for investing in mutual fund units?
Dividend income from mutual fund units will be exempt from income tax with effect from July 1, 1999. Further, investors can get rebate from tax under section 88 of Income Tax Act, 1961 by investing in Equity Linked Saving Schemes of mutual funds. Further benefits are also available under section 54EA and 54EB with regard to relief from long term capital gains tax in certain specified schemes.
Are investments in mutual fund units safe?
No stock market related investments can be termed safe with certainty as they are inherently risky. However, different funds have different risk profile which is stated in its objective. Funds which categorize themselves as low risk, invest generally in debt which is less risky than equity. Anyway, as mutual funds have access to services of expert fund managers, they are always safer than direct investment in the stock markets.
How do I find out about a scheme which suits my individual requirements?
You have to define your individual requirements and then simply go to ‘Choose a Scheme’ icon on the home page of this web site. You can select your defined parameters and get a list of schemes which would fit the needs.
As mutual fund schemes invest in stock markets only, are they suitable for a small investor like me?
Mutual funds are meant only for a small investor like you. The prime reason is that successful investments in stock markets require careful analysis of scrips which is not possible for a small investor. Mutual funds are usually fully equipped to carry out thorough analysis and can provide superior returns.
The Top 10 Reasons To Invest In Mutual Funds
Everyone who follows the financial news has heard of mutual funds and knows the stock market has generally risen (with various ups-and-downs) for over 200 years. In fact, by most measures, the stock market has made more money for more people, and done it more reliably, than any other investment over the past 100 years! If you want to accumulate substantial wealth, you must include stocks in your investments!
But, most people who "invest" don't study the market. They don't understand it, and they don't have time to manage their portfolio wisely. That's where mutual funds come in. I respect that other people have other opinions, and certainly not all mutual funds are well managed - you MUST choose wisely and use appropriate caution! But, for most folks, a good, solid, boring mutual fund is the golden path to riches.
Here are my Top 10 reasons to us mutual funds:
1. Selection. You can select from thousands of funds (you'll find one to suit your needs) and you can get information on them easily. Magazines like "Money" are easy to find. Most credit unions have information, and your local library is a goldmine - and there's the Internet.
2. You Can Start Small. Most mutual funds will let you start with less than $1000, and if you set it up for automatic deposits, some will let you start with only $50. I've spent more than that in a restaurant! There is NO reason not to consider this!
3. Simplicity. You deposit 10% of your income every month. Just pay yourself first, then pay the mortgage, then pay everyone else.
4. Professional management. I don't always have time to research, select, and monitor individual stocks. So, I pay a professional a small fee to do it for me. A good fund manager will make you rich!
5. Compound interest. Depending on what index you pick, the U.S. stock market has gone up an average of over 12% per year for the past 10 years, and it's been almost that high for the past 20 years. The market fluctuates, but the beauty of this is, you don't care! Over 10, 20, or 30 years, the system works every time!
6. Dollar-cost-averaging. The details are complicated, but by investing every single month, whether the market is up or down, you get a tremendous boost from the mathematics. Your "average cost" will always be less than the "average price" you paid! And that is money in your pocket!
7. Diversification. A broad-based growth fund typically invests in dozens of companies in different industries, sometimes even in different countries around the world. If one stock goes down, hopefully dozens of others will go up. There is excellent protection and sound risk management built-in to these funds.
8. Specialization. If you prefer, and if you do the research, there are funds that invest in only a very small number of companies. If you can accept the additional risk, you can invest in one particular industry, or one country, or in companies of a certain size or that are environmentally responsible. This specialization offers the potential for even greater profits, but it can also bring greater potential risk. Study before you invest!
9. Fund "Families". Most mutual funds are offered by management companies that sponsor several different funds, with different objectives. They make it easy to move your money between funds, so as your goals change, you can adjust your investments with a quick phone call, or on the Internet.
10. Momentum. Once you get started, your enthusiasm builds. Once you have money "in the market", you'll track it, manage it, and in all probability, your desire to save will increase. If you've had difficulty saving in the past? START! Those monthly statements will be positive reminders to do even more. Yes, you should invest in tax-sheltered retirement plans first, and yes, there are other investment possibilities. And yes, there is some risk, because the market can go down. But to retire wealthy, pick a great, long-term growth fund, invest regularly, and let the system work for you! The key, as always is: GET STARTED!
Here's to your success!
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