Understanding Mutual Funds

  • Aaditya Sridharan

Understanding Mutual Funds

The concept of mutual funds is quite simple. Many investors, with similar investment objectives, i.e. date of maturity, expected rate of return, market to invest in etc. pool their money into a MUTUAL fund that is then managed professionally by an Asset Management Company (AMC). The AMC invests in various securities and markets are in line with the investment objectives of the investors. The investment objectives also depend on many factors like financial goal, the term of investment, risk appetite, income, number of dependents on the investor etc. You can imagine that there are probably thousands of different investment objectives that are possible. It is even possible for a person to change his investment objectives from time to time. So how does the mutual fund industry cater to so many different kinds of investors? Simple. It has thousands of mutual fund schemes with diverse investment objectives so that every investor can find a scheme or a combination of schemes to match his objectives.
We will look at the different types of mutual funds later, and concentrate now on the advantages of mutual funds.

  • Professional Management
    Since a large number of investors pool a big sum of money which is then invested, the mutual funds are able to hire highly experienced professionals to manage the portfolio of the scheme. They are also able to invest in quality research before making the investments. The costs of these are distributed among the investors, and thus even a common man is able to afford professional management of his funds.
  • Economies of Scale
    To understand this concept simply, we can take the example of buying eggs. The price per egg while buying a single egg will be costlier than the price per egg while buying a dozen eggs which will again be costlier than the price per egg while buying a carton of eggs. Mutual funds are able to substantially lower the transaction costs for the investors by investing in such huge volumes. A mutual fund would also be able to put pressure on companies to protect its interests more than what an individual investor would be able to put.
  • Portfolio Diversification
    Diversification refers to the process of mixing different types of securities & investments in one portfolio to manage the risk. In the absence of a calamity like a war, it is unlikely for different types of investments to all perform poorly at the same time. Thus diversification reduces the risk of the investment.
    For an individual investor in direct equity, portfolio diversification is a very costly affair, but in mutual funds, you can get proportionate ownership of various securities in a MF Portfolio for as low as Rs 500/-.
  • Liquidity
    It may be hard sometimes to find buyers for a security that you own. It is even possible for the company to have vanished. But in Mutual Funds, the investor can redeem the current value of his investment directly from the mutual fund. Depending on the type of mutual fund, this could be done at any time, during pre-specified intervals, or only on the maturity of the scheme.
  • Convenient Options
    Not only does the investor have a huge variety of schemes to choose from, there are also options within a scheme to allow the investor to structure the scheme to best suit his needs. There are also options to withdraw part of the money from the investment account, invest additional amounts or set up systematic transactions like SIPs, SWPs etc.
  • Regulatory Comfort
    The Securities and Exchange Board of India (SEBI) has put in place strict checks and balances in place in the structure of mutual funds to ensure that investors are at the top priority always.

Like with everything in this world, there are also a few disadvantages of investing in mutual funds. They are:
  • No Portfolio Customization
    An investor in a mutual fund is only one of thousands of other investors in the scheme. The invested amount goes into the hands of the fund manager, and the investor cannot influence what securities or investments are made by the scheme.
  • Overload of Choice
    There are over 2000 Mutual Fund Schemes available in India. It becomes very hard for a layman to understand the pros and cons of each scheme and understand which is best for him.
  • No control over costs
    The costs incurred in the management of the funds are shared by all the investors in proportion to their invested amount. Thus, an individual investor has no control over the costs in a scheme. The money that is raised from the investors ultimately benefits governments, companies and various other entities that the mutual fund invests in. This can be in turn used by the entities invest in various projects, generate employment and increase productivity. The overall economic development of a country is promoted.
It can be said, with quite a bit of confidence, that the pros far outweigh the cons of investing in a mutual fund, especially for the majority of the population, who do not have the capital to hire professional managers to handle their individual account, or the knowledge to select the right securities or investments to invest in. Mutual funds give an average person the ability to exploit the tremendous potential of growth in value of his wealth that is available by investing in the stock market.

Aaditya Sridharan

Aaditya Sridharan is an engineer by degree, but an analyst by heart. He is incredibly fascinated by the markets and the potential they hold for any intelligent investor. He hopes to help people realize the true potential of their wealth and change the norm of keeping the savings in a bank account that is prevalent in the country.