As you probably know, mutual funds have become extremely popular over the last 20 years. What was once just another obscure financial instrument is now a part of our daily lives
In fact, to many people, investing means buying mutual funds. After all, its common knowledge that investing in mutual funds is (or at least should be) better than simply letting your cash waste
A mutual fund is nothing more than a collection of stocks and/or bonds. You can think of a mutual fund as a company that brings together a group of people and invests their money in stocks, bonds, and other securities. Each investor owns shares, which represent a portion of the holdings of the fund.
You can make money from a mutual fund in three ways:
1) Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution.
2) If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
3) If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit.
Funds will also usually give you a choice either to receive a check for distributions or to reinvest the earnings and get more shares.
Advantages of Mutual Funds:
• Professional Management – The primary advantage of funds (at least theoretically) is the professional management of your money. Investors purchase funds because they do not have the time or the expertise to manage their own portfolios. A mutual fund is a relatively inexpensive way for a small investor to get a full-time manager to make and monitor investments.
• Diversification – By owning shares in a mutual fund instead of owning individual stocks or bonds, your risk is spread out. The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others. In other words, the more stocks and bonds you own, the less any one of them can hurt you (think about Enron). Large mutual funds typically own hundreds of different stocks in many different industries. It wouldn’t be possible for an investor to build this kind of a portfolio with a small amount of money.
• Economies of Scale – Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are lower than what an individual would pay for securities transactions.
• Liquidity – Just like an individual stock, a mutual fund allows you to request that your shares be converted into cash at any time.
• Simplicity – Buying a mutual fund is easy. Regular tracking of your investments is possible even for investors with little time and no expertise. Most companies also have automatic purchase plans whereby as little as Rs 100 can be invested on a monthly basis.
Different Types Of Mutual Funds
No matter what type of investor you are, there is bound to be a mutual fund that fits your style.
Types of mutual find schemes are as follows :-
|By Structure||By Investment Objective||Other Schemes|
|Open – Ended Schemes||Growth Schemes||Tax Saving Schemes|
|Close – Ended Schemes||Income Schemes||Special Schemes|
|Interval Schemes||Balanced Schemes||Index Schemes|
|Money Market Schemes||Sector Specfic Schemes|
Aim to provide capital appreciation over medium to long term. The majority of their funds are invested in equities and hence bear the risk of short term decline in value for possible future appreciation.
Investtors in their prime earning years.
Investors seeking growth over long term.
Open Ended And Close Ended Funds
Most mutual funds are open-ended funds. This means you can subscribe to one at any time of the year. Open-ended funds are generally not listed on stock exchanges. A converse set of rules apply to closed-ended funds. Closed-ended funds have a fixed number of shares, are open for subscription during a specified period and operate for a fixed period of time. For example, five years – and so, the number of buyers and sellers are exact – someone would have to sell for you to be able to buy. Closed-ended funds are generally listed on stock exchanges.
Each fund has a predetermined investment objective that tailors the fund’s assets, regions of investments and investment strategies. At the fundamental level, there are three varieties of mutual funds:
1) Equity funds (stocks)
2) Fixed-income funds (bonds)
3) Money market funds
All mutual funds are variations of these three asset classes. For example, while equity funds that invest in fast-growing companies are known as growth funds, equity funds that invest only in companies of the same sector or region are known as specialty funds.
Let’s go over the many different flavors of funds. We’ll start with the safest and then work through to the more risky.
Money Market Funds
The money market consists of short-term debt instruments, mostly Treasury bills. This is a safe place to park your money. You won’t get great returns, but you won’t have to worry about losing your principal. A typical return is twice the amount you would earn in a regular checking/savings account and a little less than the average certificate of deposit (CD).
Income funds are named appropriately: their purpose is to provide current income on a steady basis. When referring to mutual funds, the terms “fixed-income,” “bond,” and “income” are synonymous. These terms denote funds that invest primarily in government and corporate debt. While fund holdings may appreciate in value, the primary objective of these funds is to provide a steady cash flow to investors. As such, the audience for these funds consists of conservative investors and retirees.
Bond funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren’t without risk. Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high-yield junk bonds is much more risky than a fund that invests in government securities. Furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up the value of the fund goes down.
The objective of these funds is to provide a balanced mixture of safety, income and capital appreciation. The strategy of balanced funds is to invest in a combination of fixed income and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed income. The weighting might also be restricted to a specified maximum or minimum for each asset class.
A similar type of fund is known as an asset allocation fund. Objectives are similar to those of a balanced fund, but these kinds of funds typically do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given freedom to switch the ratio of asset classes as the economy moves through the business cycle.
Funds that invest in stocks represent the largest category of mutual funds. Generally, the investment objective of this class of funds is long-term capital growth with some income. There are, however, many different types of equity funds because there are many different types of equities.
Risk factors associated with investing in mutual funds
Mutual funds and securities investments are subject to market risks and there is no assurance or guarantee that the objectives of the schemes will be achieved
As with any investment in securities, the NAV of the units issued under the schemes can rise or fall depending on the factors and forces affecting capital markets
Neither the past performance of the mutual funds managed by the sponsors and their affiliates / associates nor the past performance of the sponsors, asset management companies (AMC) or fund is necessarily indicative of the future performance of the schemes
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