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  Mutual Funds

home > Mutuals Funds > Basics of Mutual Funds > Introduction to MFs
 INTRODUCTION TO MUTUAL FUNDS

Introduction

 
While everyone dreams of a luxurious life, very few fulfill them. A luxurious life is generally linked with wealth. So, the question most people would like to know is: How do I create wealth? Or how can I get rich? It's really not that difficult to create wealth. It's just a matter of systematic planning and disciplined approach. Once you have small amounts saved up, then you can start looking into ways to use that money to create more money. Money can multiply through investments in the stock market, real estate, commodities, etc. One avenue which invests in all is mutual funds. Therefore, one of the crucial ways, people can build their core capital is by investing in a mutual fund.

Once you have small amounts saved up, then you can start looking into ways to use that money to create more money. Money can multiply through investments in the stock market, real estate, commodities, etc. One avenue which invests in all is mutual funds. Therefore, one of the crucial ways, people can build their core capital is by investing in a mutual fund.
   
What is a Mutual fund?
 
A mutual fund basically pools the money of investors, who share some common financial objective. This money is invested in capital market instruments like shares, debentures and other securities and also in other investible avenues such as real estate, commodities etc. Income thus earned and the capital appreciation realised, are shared by its unit holders (investors) in proportion to the number of units owned by them.
   
How is mutual fund investing different from investing in stock markets?
 
The following table lists down the advantages and disadvantages associated with adopting the two approaches to investing.
 
Investing through mutual funds Investing in stock markets directly
Positives Positives
1: An investor with small amount can invest small amount and can have exposure to large number of stocks. 1: Investor with reasonable investment surplus can pick stocks according to his discretion.
2: Fund manager takes care of the portfolio performance through his expertise in analysing the company's performance and the outlook on market scenario. So the investor just has to track the fund's performance. 2: The right calls in the right stocks offer better returns.
3: The cost of churning is low when investment are made through mutual funds. 3: The investor can exploit the right opportunities (such as bonus/dividend, selection of appropriate IPOs issues) according to his choice of time and money from the universe of stocks.
4: Investors can geographically diversify their portfolio by putting their money in funds which invest in international markets. 4: The investor can earn higher return through future and options. But it involves higher risk compared to equity market.
5: SIP approach, which is a practical tool for long-term wealth creation, can be opted in mutual funds.  
6: With the usage of derivative instruments (which help limiting the downside), the investor benefits by earning higher risk-adjusted returns than the market.  
7: By investing through mutual funds which invest in IPOs, retail investors can invest in a large number of IPOs, for whatever amount he is ready to invest.  
Short comings Short comings
1: Investor doesn't have the freedom of getting a desired allocation to specific stocks and sectors as it is decided by the fund manager. 1: It doesn't offer a user-friendly environment for the investment in IPOs due to following reasons.
  • The investor can't invest in large no of IPOs at the same time due to the high up front application amount.
  • There is a limit on the investment amount in IPOs.
  • The investor may not be allotted the desired number of shares applied by him due to oversubscription.
2: Mutual fund investors have to shell out loads and bear the fund management fee charged by the mutual fund house and the AMC. 2: Investor has to keep a track of the market and the individual stocks as well. This whole process requires more of time, efforts and expertise.
  3: To limit his downside through F&O market, investor has to pay a hefty sum as margin money. Further, F&O trading requires constant market tracking which is a very time consuming task.
  4: Investing in international market might prove to be an expensive affair for retail investors.
  5: Relatively high cost of churning, as short-term capital gains tax comes into picture.
bullet Benefits of mutual funds
  1. Sets the investor free from four main constraints:
 
  1. Convenience and Knowledge: The investor need not go through the tedious task of research and stock selection and need not track the market to manage the portfolio.
  2. Time: Frees one from spending his precious time to track his portfolio everyday.
  3. Complexity: Frees from the complexity involved in equity and debt markets.
 
2. Diversification: Investing in mutual funds enable a well-diversified portfolio, with a very small amount of investment. Diversification across various securities lowers the risk associated with investment.
 
3. Higher risk-adjusted returns: Majority of equity funds have outperformed indices while other avenues like fixed deposits, post-office schemes etc. have delivered lower returns.
 
4. Professional management: Investors purchase funds because they do not have time or expertise to manage their own portfolio. A mutual fund is relatively an inexpensive way for a small investor to get a full-time manager to create and monitor his portfolio.
 
5. Low entry barrier: Any investor can invest in mutual funds. He need not open a broking or a demat account to invest in mutual funds. Further, investment can be made in mutual funds with an amount as low as Rs. 500.
 
6. Liquidity: Easy and fast redemption leads to high liquidity. Also, one can enter and exit the fund (open-ended) depending on his discretion.
 
7. Transparency: The transparency levels are very high in this industry. Investors can view his fund's NAV on a daily basis. Also, majority of the funds disclose their portfolio holdings on a monthly basis.
 
8. Tax-saving: Mutual funds are exempted from capital gains arising out of portfolio churning. If an investor shifts his holdings, he will have to pay these taxes. Thus, mutual funds are a cost-efficient way of portfolio management. Also, there are ELSS funds (tax saving funds) which help availing the benefit of tax-saving u/s 80C. As compared to other tax saving avenues, they have lowest lock-in period and also offer higher return potential.
 
9. Innovative schemes to suit unique needs of different investors: There are schemes that offer international diversification to reduce the geographical risk. There are derivative funds which adopt various derivative strategies to gain from the either side movement of the market. Capital protection funds offer a unique feature of capital protection coupled with market linked returns.
   
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