What is Mutual Fund
A mutual fund is a common fund or pool of money, created and formed by different people or entities, to invest in stocks, bonds, or government securities etc., as per the wish of all the investors put together. It’s a legal financial institution which connects a group of investors with a common investment objective.
Example- You want to invest in shares and find 10 other people who also wants to invest in shares. You all come together and form a pool of Rs 50000 with all 11 people as investors. This pool of Rs 50000 is a mutual fund, as it is a fund created for mutual benefit.
Some basic features of Mutual fund are
- what is mutual fund- It is a legal common pool of money
- Money from- Investors with a common objective, brings the money to invest
- Investment in- Investment can be in Shares, Bonds, Real estate etc. as per wish of investor
- Units- Investors get units of the mutual fund, for their investment
- Who Does Investment- Expert Fund Manager does all investment
- Who Appoints Fund Manager- Investors
- What About Profits from Investment- All profits from investments are given back to investors
Each investor owns units in the Mutual Fund and income earned from the fund is shared by unit holders in a proportion of their investment.
A Mutual Fund is required to be registered with Securities and Exchange Board of India, which regulates securities markets before it can collect funds from the public. The mutual fund has investments strictly as per investment objective of the fund. Some of the features of mutual funds are -
Some basic benefits of investing in Mutual fund are
- Stress – Stock or bond markets are very volatile and one needs to be very skillful and efficient for profitable investing directly. Whereas in mutual funds, fund manager, and his team takes care of your money and takes the best decision on your behalf. You have to just invest and trust.
- Professional Expert Management- You don’t need to be having any kind of knowledge on the investing. Fund managers will do all the transactions.
- Diversification- A small investor can’t diversify the investment portfolio with small investment surplus. With mutual funds, one can get a diversified portfolio, even with a few investment of Rs 500.
- Small money can be invested – You can start investing in a mutual fund with even Rs500 , which is not possible in case you want to invest in shares. Shares of some of the listed companies trade at higher prices, which can’t be owned by small investing directly with small amounts.
- Tax Benefits- In equity mutual funds, all returns are tax free if investments are held for more than 1 year. Additionally, In ELSS (Equity Linked Saving Schemes) funds, one gets a deduction up to Rs 150000 under section 80C of income tax act.
- Liquidity- Mutual funds are highly liquid. One can buy or sell open-ended mutual fund schemes any time.
Some basic disadvantages of investing in Mutual fund are
- Nil Insurance: Mutual funds are market linked investments. No scheme in India can offer a capital guarantee or minimum returns . Though return depends on the investment objective, nevertheless, mutual funds don’t bring any insurance of principle safety.
- Fees and Expenses: Most mutual fund charges annual fees to meet various kind of expenses. This fee depends on the schemes. Equity mutual fund generally has higher charges, which sometimes can be taxing in bad markets.
- Poor Performance: Performance of mutual fund schemes depend on market and wisdom of fund manager. In case fund manager’s actions goes against the market, it can bring negative surprises.
- Loss of Control: You can not interfere in fund management decisions of a mutual fund scheme. This way investor looses the control of his or her investments.
- Trading Limitations: Though mutual funds are liquid and there are no investing limitations, but there are recent innovations like close-ended mutual fund schemes or ELSS funds which can bring a lot of transaction limitations.
- The inefficiency of Cash Reserves: Mutual funds sometimes can maintain large cash holdings to protect against market fall or to capture any expected opportunity. This can affect the overall performance of the fund as cash holdings don’t give any kind of returns.
- Too Many Choices: There are more than 500 equity funds in India. This creates a lot of problems for a small investor to make a choice.