INVESTMENT-MUTUAL FUND –ALL YOU NEED TO KNOW

In order to have some effective in stock market, the tendency is now to form a group of persons and the to carry the business under a particular mutual fund scheme. Every persons ha to contribute for becoming a member of the group and the benefits realized are shared by the members of the association. The government has evolved some machinery to ensure that the mutual funds set up in different segments function properly and their actions are not to be detriment of the savers. In some developed countries, hundreds of mutual funds have been set up with specific objectives and aiming to serve specific types of savers.

 

A mutual fund is professionally-managed form of collective investment that pools money from many investors and invest it in stocks, bonds, short-term money market instruments, and /or other securities, Nowadays, bank rates have fallen down and are generally below the inflation rate. Therefore, keeping large amounts of money in bank is not a wise option, as in real terms the value of money decreases over a period of time . One of the options is to invest the money in stock market. But a common investor is not informed and competent enough to understand the intricacies oF stock market. This is where mutual funds come to the rescue .

A mutual fund is a group of investors operating through a fund manager to purchase a diverse portfolio of stocks or bonds. Mutual funds are highly cost efficient and very easy to invest in. By pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. Also, one doesn’t have to figure out which stocks or bonds to buy.

 

Advantages of Mutual Funds

There are many reasons why investors choose to invest in mutual funds with such frequency. Let’s break down the details of a few.

Advanced Portfolio Management

When you buy a mutual fund, you pay a management fee as part of your expense ratio, which is used to hire a professional portfolio manager who buys and sells stocks, bonds, etc.1 This is a relatively small price to pay for getting professional help in the management of an investment portfolio.

Dividend Reinvestment

As dividends and other interest income sources are declared for the fund, they can be used to purchase additional shares in the mutual fund, therefore helping your investment grow.

Risk Reduction (Safety)

Reduced portfolio risk is achieved through the use of diversification, as most mutual funds will invest in anywhere from 50 to 200 different securities—depending on the focus. Numerous stock index mutual funds own 1,000 or more individual stock positions.

 

Convenience and Fair Pricing

Mutual funds are easy to buy and easy to understand. They typically have low minimum investments and they are traded only once per day at the closing net asset value (NAV).1 This eliminates price fluctuation throughout the day and various arbitrage opportunities that day traders practice.

Disadvantages of Mutual Funds

• High Cost: There are no free lunches in this world. Similarly, mutual funds also come with costs in the form of expense ratios. Expense ratio covers fund management fees, marketing and sales costs etc.

A high expense ratio directly affects your portfolio returns. Investors who prefer a lower expense ratio can invest in ‘index funds’.

• Misuse of Management Authority: Some fund managers may unnecessarily churn the portfolio. Portfolio churning is constant buying and selling of stocks.

High portfolio churning increases taxes and other costs. This reduces portfolio returns. Constant churning can also result in your fund manager making poor investment decisions which can lead to substantial losses.

• Comk-in Period: ELSS and FMPs come with fixed comk-in periods. They are highly illiquid and cannot be used during emergencies. Ideally mutual fund beginners should avoid FMPs.

ELSS funds are a great tax saving option. But only investors who can stay invested for a minimum of 3 years should invest in ELSS funds.

• Exit Load: Exit load is a penalty charged by the fund house on redemption before a specific period. Different types of fundscarry different exit load periods:

1. • Liquid funds have an exit load period of 7 days.
   • Debt funds have an exit load period of 30 days – 540 days (credit risk debt fund)
   • Equity funds have an exit load period of 365 days.

Investors should match their financial goals with the fund’s exit load period. For example: If an investor wants to invest for 10 days, then he should invest in liquid funds not debt funds.

• Over-Diversification: Diversification is a double-edged sword. While it reduces risk, it also dilutes profits earned by investors. At times fund managers invest in too many asset classes. This is known as over-diversification. To avoid this, investors should do goal-based financial planning before investing.
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