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A Mutual fund is a type of investment that raises money from investors and uses them to purchase securities like stocks, bonds, etc. The funds are managed by an investment professional called a portfolio manager. The portfolio manager must find out the best investment pool which provides potential returns. The gain or loss will be divided among the investors as per their proportion of shares to the fund.
The collected fund is invested mainly in government bonds, shares of listed companies, short-term bonds, short-term money market instruments, or a combination of the above listed. The management of funds is vested with the fund manager. There will be one or more than one fund manager which is purely based on the Mutual Fund Schemes.
How did Mutual Funds work?
A mutual fund is a company as well as an investment. We can say that a Mutual Fund is a dual-nature one. i.e That is when you invest in a mutual fund you get partial ownership in a mutual fund company.
The Process of Mutual Fund investment starts with the Launch of new schemes. This is termed a New Fund Offer (NFO). The investors closely watch the fund’s strategy and Subscribe to NFO. They also consider the Objectives of the fund, Cost of the investment, risk, tenure, etc before purchasing units.
After that money is pooled. A small amount from the savings is invested by the investors. The pooled money will be invested in shares of listed companies, Government bonds, Securities, etc.
The fund manager is the person who finds out securities to invest in. He will make a thorough study about potential returns and risks and make selections. The monitoring and rebalancing of portfolios increase the fund’s Net Asset Value. When the fund gets returns it will be distributed among the investors according to the proportion of their investment. If the returns are retained in the fund, they will be further invested resulting in more wealth to investors.
Concept of Mutual Fund
The above paragraphs give you a brief idea about what is a mutual fund and how does it work. Next, we need to know the concept of Mutual Funds. Let us know more about it with a simple example.
A Packet of pen costs Rs.50 containing 10 pen.10 people wants to buy the same. But they have only 5 rupees each. The shopkeeper only sells the packet not one by one. So these people agree to pool Rs. 5 each and buy the packet. Now based on their contribution, each one receives 1 pen.
This is how a Mutual Fund is done. There will be a group of small investors pool their money and invest in a portfolio which is sorted by a portfolio manager.
Types of Mutual Funds
Mutual funds can be broadly classified based on:-
- Open-ended scheme – It is open for subscription and repurchase continuously on all business days.
- Close-ended scheme – Unlike open-ended, this has a fixed maturity date. Units are issued on an initial offer and redeemed only on the maturity date.
- Interval Schemes – As the name suggests these schemes allow purchase and redemption during specific intervals. The transaction period has to be a minimum of 2 days to a maximum of 15 days.
2.Management of Portfolio
- Active Scheme – The portfolio manager has an active role in the selection and buying of funds.
- Passive Scheme – The Manager has only a passive role.
- Growth funds – Schemes formulated to provide capital appreciation.
- Income Funds – Scheme designed to provide regular and steady income.
- Liquid Funds – Funds invested in money market instruments with a maturity not exceeding 91 days.
- Equity – Invest a major part in equities
- Debt – Invest in fixed income securities such as bonds, government securities, etc
- Hybrid – Invest in a mix of equity and debt instruments
The other types include Exchange Traded Funds, Overseas Funds, Fund of Funds, etc.
Pros and Cons
- Liquidity – It is relatively easy to buy and exit mutual funds.
- Diversification – Here the investor can buy units from a large number of options
- Cost Efficiency – Compare with other mutual funds and opt for the less costly one.
- Suits Financial Goals – Irrespective of the income the different mutual funds in the market help us to plan according to our income and invest in it.
- Costs of managing fund – In addition to the operational cost of the fund the investor has to meet the salary of the portfolio manager also.
- Exit load – There is a fixed fee for exiting a Mutual Fund which is fixed by the Asset Management Company
- Dilution – Investing in more than one Mutual Fund may result in dilution of profit.
Investors may not have the time to analyze, research, and find out the best possible combination of portfolios. Here the portfolio managers will help them to choose and monitor and rebalance funds. As we see above the pros have more weightage than cons of Mutual Funds, it is a greater way to get potential returns to small investors reducing the risk.