Understanding mutual funds
What if you could invest your money and have someone else professionally manage it for you? Services like these do exist, but they come with a requirement of high amounts of capital or money to be invested. What if you could avail such a service, even with a small investment and get the advantage of professional money management? Well, this is possible by investing in mutual funds.
What is a mutual fund?
A mutual fund is essentially a common pool of money in which investors put in their contribution. This collective amount is then invested according to the investment objective of the fund.
The money could be invested in stocks, bonds, money market instruments, gold and other similar assets. These funds are operated by money managers or fund managers, who by investing in line with the specified investment objective attempt to create growth or appreciation of the amount for investors.
For example, a debt fund will have its specified objective to invest in fixed income instruments or products like bonds, government securities, debentures, etc. Similarly, an equity fund will invest in stocks and other equity instruments.
Before you launch yourself into choosing a mutual fund and investing your money, you should first be clear about what it actually means. After all, you wouldn’t want to invest your hard-earned money just anywhere, would you!
Starting with a basic definition, a mutual fund is nothing but a pooling entity, specifically for investments, which is managed in a professional manner by many of the Asset Management companies we have in the world. It’s an entity or a group wherein investors like yourself invest their money in stocks and bonds, amongst other available avenues. If you become one of the investors, you will be assigned certain mutual fund units that will indicate the contribution you’d have made towards a particular scheme. After a while, you can either buy or redeem the same units on an as-per-need basis, at whatever the fund’s prevailing net asset value (NAV) might be. We say ‘prevailing’ because a mutual fund has its NAV changing on almost a daily basis, depending on how the valuation of underlying assets of the fund might change.
We are a little biased towards mutual funds, not just because they give higher returns, but also because in order for them to even operate, they have to compulsorily register as well as operate within the regulations set by SEBI. The major benefit, though, is that even if you make a relatively small investment, you still get to have access to a diverse range of professional fund management portfolios.
Some common categories of mutual funds are:
> Equity funds – funds that invest only in stocks and other equity instruments
> Debt funds – funds that invest only in fixed income instruments
> Money market funds – funds that invest in short-term money market instruments
> Hybrid funds – funds that divide investments between equity and debt to create a balance
What is the benefit of investing in mutual funds?
One of the key advantages of investing in a mutual fund is that each investor (even with a small investment) gets access to professional money management and expertise. Also, it would be very difficult for an investor to create a diversified portfolio of investments on his own with a small amount of money. With mutual funds, each investor participates proportionally in the return the scheme generates.
Each unit gets a proportional share of gain (or bears loss) from the fund. There is a portfolio report generated for each investor, which tracks all investments and the returns generated by the mutual fund.
How to Invest in Mutual Funds (Short Term)
- Now that you are absolutely sure of your decision to invest in mutual funds, we are going to embark on the next step – how does a person invest in a mutual fund.
Take note of these very simple 5 steps, and you’ll be good to go.
- First off, have a good understanding of your risk tolerance as well as risk capacity. In other words, this is called risk profiling which means you need to identify the amount of risk that you would be capable of taking.
- The second step for you should be, asset allocation. Once you know you’ve done your own risk profiling, you should begin dividing your money between the different asset classes. Try to do this in a way that your asset allocation has a mix of both debt instruments as well as equity so that you will have a better chance of balancing out the risks.
- Next up, identify the mutual funds that invest in each of the asset classes. You could compare these funds based on the investment objective and their past performance.
- The fourth step will be you deciding which mutual fund schemes you’d like investing in, and subsequently submitting the application either online or offline.
- The last step is something that you need to do regularly – that is, diversify your investments and keep taking follow-ups so as to make sure you get the best out of your investment.