Mutual Funds Basics

What Are Mutual Funds?

A mutual fund is an investment vehicle, which pools money from investors with common investment objectives. It then invests their money in multiple assets, in accordance with the stated objective of the scheme. The investments are made by an ‘asset management company’ or AMC.

For example, an equity fund would invest in stocks and equity-related instruments, while a debt fund would invest in bonds, debentures, etc.

As an investor, you put your money in financial assets like stocks and bonds. You can do so by either buying them directly or using investment vehicles like mutual funds.

In this segment, we will understand mutual funds and how to trade in them.

History Of Mutual Funds In India

Mutual funds in India have come a long way since 1964 when the Unit Trust of India was the only player.

By the end of 1988, UTI had total assets worth Rs 6,700 crore. Soon after, eight funds were established by banks, LIC and GIC between 1987 and 1993. The total number of schemes went up to 167 and total money invested – measured by Assets under Management (AUM) – shot up to over Rs 61,000 crore.

In 1993, private and foreign players entered the industry, marking the third phase. The first entrant was Kothari Pioneer Mutual fund, which launched in association with a foreign fund.

The Securities and Exchange Board of India (SEBI) formulated the Mutual Fund Regulation in 1996, which, for the first time, established a comprehensive regulatory framework for the mutual fund industry. Since then, several mutual funds have been set up by the private and joint sectors.

Currently there are around 45 mutual fund organizations in India together handling assets worth nearly Rs 10 lakh crore. Today, the Indian mutual fund industry has opened up many exciting investment opportunities for investors. As a result, we have started witnessing the phenomenon of savings now being entrusted to the funds rather than in banks alone. Mutual Funds are now perhaps one of the most sought-after investment options for most investors.

As financial markets become more sophisticated and complex, investors need a financial intermediary who can provide the required knowledge and professional expertise on taking informed decisions. Mutual funds act as this intermediary.

Why Invest In Mutual Funds

Investing in mutual funds offers a multitude of benefits. Let’s have a look:

• Professional Investment Management

When you invest in a mutual fund, your money is managed by professional experts. This is one of the primary benefits of investing in mutual funds. Being full-time, high-level investment professionals, a good investment manager is more resourceful and capable of monitoring the companies the mutual fund has invested in, rather than individual investors.

The managers have real-time access to crucial market information and are able to execute trades on the largest and most cost-effective scale. Simply put, they have the know-how to trade in the markets that retail investors may not possess.

• Low Investment Threshold

A mutual fund enables you to participate in a diversified portfolio for as little as Rs 5000, and sometimes even lesser. And with a no-load fund, you pay little or no sales charges to own them.

For example, some bonds and fixed deposits have a minimum investment amount of Rs 25,000. Instead, you can give your money to a mutual fund, which will in turn invest in the bonds and fixed deposits. This could be done for as little as Rs 1000.

• Professional Investment Management

When you invest in a mutual fund, your money is managed by professional experts. This is one of the primary benefits of investing in mutual funds. Being full-time, high-level investment professionals, a good investment manager is more resourceful and capable of monitoring the companies the mutual fund has invested in, rather than individual investors.

The managers have real-time access to crucial market information and are able to execute trades on the largest and most cost-effective scale. Simply put, they have the know-how to trade in the markets that retail investors may not possess.

• Convenience

Investing in mutual funds has its own convenience. You save up on additional paper-work that comes with every transaction, the amount of energy you invest in researching the stocks, as well as actual market-monitoring and conduction of transactions. With a mutual fund, you don’t have to do any of that.

Simply go online or place an order with your broker to buy a mutual fund. Another big advantage is that you can move your funds easily from one fund to another, within a mutual fund family. This allows you to easily rebalance your portfolio to respond to significant fund management or economic changes.

• Liquidity

In open-ended schemes, you can get your money back at any point in time at the prevailing NAV (Net Asset Value) from the Mutual Fund itself.

This makes mutual fund investments highly liquid. Compare that with a fixed deposit or a bond which may have a fixed investment duration.

• Variety

While investing in mutual funds, you are spoilt for choice. You have a number of mutual fund schemes to choose from, which may invest in a whole range of industries and sectors, different kinds of assets, and so on. You can find a mutual fund that matches just about any investment strategy you select.

There are funds that focus on blue-chip stocks, technology stocks, bonds, or a mix of stocks and bonds. In fact, the greatest challenge can be sorting through the variety and picking the best for you.

• Transparency

SEBI regulations for mutual funds have made the industry very transparent. You can track the investments that have been made on your behalf to know the sectors and stocks being invested in.

In addition to this, you get regular information on the value of your investment. Mutual funds are mandated to publish the details of their portfolio regularly.

How To Choose A Mutual Fund

Money is precious. It is hard-earned. You can’t just put your money in an investment vehicle or mutual fund without some research.

Here are some things to keep in mind while choosing a fund:

• Past Performance

History is important. Before investing, check the historic performance of the mutual fund scheme, the asset manager’s investment decisions, fund returns and so on. While the past performance is not an indicator of the future, it could help you figure out what to expect in the future. You can understand the investment philosophies of the fund and the kind of returns it is offering to investors over a period of time. It would also make sense to check out the two-year and one-year returns for consistency.

Statistics such as how the fund had performed in the bull and bear markets of the immediate past would help you understand the strength of a fund. Tracking the fund's performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls during a bearish phase.

• Match The Scheme's Risk With Your Profile

Even though a mutual fund diversifies its portfolio to reduce risk, they may eventually invest in a single type of asset. The risk of the fund varies with the kind of assets it is invested in. For this reason, check if the mutual fund fits your risk profile and investment horizon. For example, certain sector-specific schemes come with a high-risk, high-return tag. Such plans are suspected to crash in case the industry or sector loses the market's fancy. If the investor is risk-averse, he could instead opt for a debt scheme with little risk.

However, if you are a long-term investor, who doesn’t mind risk, you could go ahead with the sector-specific mutual fund scheme. For this reason, most investors prefer balanced schemes, which invest in a combination of equities and debts. They are less risky than pure equity or growth funds, which are likely to give greater returns, but more risky than pure debt plans.

• Diversification

While choosing a mutual fund, one should always consider factors like the extent of diversification that a mutual fund offers to your portfolio. A mutual fund can offer diversification either by investing in multiple assets, or by balancing your overall portfolio.

For example, suppose your portfolio contains 70% exposure to stocks from different industries, then it makes sense to invest the 30% in a debt fund to balance the portfolio. Similarly, if your portfolio has a lot of exposure to a particular sector like IT, then avoid investing in a mutual fund that also invests in IT. This way, you can balance your exposure to a similar kind of risk.