Mutual Fund Meaning, Definition, Advantages

Mutual Fund Meaning

A mutual fund is a mechanism for collecting money from different investors who share a common investment objective. The money is managed by a highly qualified professional fund manager who invests the money in various securities like shares, bonds, debentures, money market instruments like T-bills, CDs, CPs or even gold. And the returns thus generated is distributed proportionately amongst the investors after deducting applicable charges. For managing the funds, the asset management company charges some fee taken in the form of expense ratio. This expense ratio could be typically between 1-3% of your total investment amount.

How does a mutual fund work?

A mutual fund house collects money from investors and creates a pool of money. A Fund Manager then uses this pool of money to invest in various securities. The mutual fund will earn returns from the securities in the form of interest, dividends or capital appreciation. It distributes the investors’ returns proportionately after deducting some portion for them to run the business called management expenses or expense ratio.

 

mutual fund meaning

How to Invest in Mutual Funds?

You can invest in mutual funds either in Lumpsum or through Systematic Investment Plan (SIP). SIP means invest some amount daily, monthly or quarterly, just like Recurring Deposit (RD). In SIP, mutual funds use the auto-debit facility in which amount will be auto-debited from your bank account as per the date specified by you when opening the SIP. Nowadays you can start a SIP even with Rs 100. Mutual fund schemes have units just as the company has shares. Just as the price of a share is known by its current market price, similarly, the price of a unit is known by its Net Asset Value or NAV. It is updated and published daily on the AMFI website after 11 pm on all trading days. If you start your SIP on 1st of every month, whatever will be the NAV of that mutual fund scheme on that day, you will get the units at that NAV.

E.g. Suppose there is a mutual fund called XYZ, whose NAV is Rs 10, i.e., one unit’s price is Rs 10. If you invest Rs 1000 in XYZ mutual fund, you will get Rs 1000/10 =100 units of XYZ. After one year, if the NAV of XYZ mutual fund increases from Rs 10 to Rs 12, your total investment value will be 100 units x Rs 12= Rs 1200. If you redeem or sell off units of any equity mutual fund schemes within one year, then mutual fund company will charge an exit load of 1%.

Before 2009, mutual fund companies charge entry load for investing any mutual funds. In 2009, SEBI, the market regulator banned entry load on all mutual fund schemes giving great relief to all investors.

When a company issue shares to the public for the first time, it is called Initial Public Offering or IPO. Similarly, when a mutual scheme is launched, then it brings New Fund Offer or NFO. You will get all the details about the mutual fund like its goals, objectives, risk & rewards, benchmark, load & expenses etc. in the offer document published on that mutual fund’s website before bringing the NFO. So, before investing in any mutual fund schemes, you must read its offer document.

mutual fund meaning

Advantages of Mutual Funds

  • Diversification– The most significant advantage of mutual funds in comparison to other investments is diversification. Your risk gets reduced due to diversification because you are not investing in one security or stock. If one thing crashes, it won’t affect your money. Compared to the stock market, gold, real estate, mutual funds are less risky; however, the exact risk depends on the types of mutual fund schemes you are investing.
  • Liquidity– It offers the convenience of liquidity i.e. that you can withdraw your money anytime. It is almost like keeping your money in your existing bank account. The only difference your money has a better chance to grow in a mutual fund.
  • Convenience– It is very convenient to start a mutual fund. Just by sitting at your home,you can open an account in any mutual fund house and start investing.
  • Expert Management– All the mutual fund’s investment is made by a professional fund manager who decided where to invest and where not to. You don’t need to make decisions as an expert is working for you.
  • Affordability– It is more affordable. No matter how much you earn or your risk appetite, there is a plan for all of us. You don’t have to invest a big amount altogether. Through Systematic Investment Plan (SIP), you can even start with a minimal amount as low as Rs 100 daily, monthly and quarterly as per your suitability.
  • Better Returns– Compared to traditional investment options like Savings in a Bank account, FDs, RDs etc. you can earn decent returns that may be more than 20%, 30% etc. if you choose a good mutual fund scheme and a good fund manager.
  • Well-Regulated– Mutual Funds are regulated by SEBI, which means it is always under constant SEBI’s supervision. So, there is significantly less chance of fraud.
  • Tax Benefits– You can avail long-term capital gain tax benefits up to Rs 1 lakh in equity mutual fund schemes. Through ELSS mutual fund schemes, you are exempted from income tax under Section 80C up to Rs 1.5 lakh.

Limitations/ Disadvantages of Mutual Funds

Even though there are so many advantages of investing in mutual funds, still there are some limitations/disadvantages in mutual funds.

  • No control– You cannot take your own decisions in choosing companies and stocks and where to invest. The fund manager fully controls it. Although he is an expert, you can’t trust 100% that an expert will be right all the time.
  • Market Risks– Mutual funds are subject to market risks. If you chose a wrong fund manager then he/she might lose your money by investing in wrong stocks.
  • Too many options– There are too many types and subtypes of mutual funds schemes available in the market. So, selecting the right fund can be a challenging task.
  • Charges– You have to pay expense ratio to the Asset Management Company for managing your funds. You have to pay an exit load if you withdraw your money before the specified time period. E.g. you have to pay 1% exit load if you redeem your money before one year in some mutual fund schemes.

Important points to remember

  • The returns generated by mutual fund schemes are expected returns, not the guaranteed return. Since the mutual fund has given a good performance in history doesn’t mean that it will perform in the same way in the future. As it depends on the market, it carries a risk. So, don’t just look at the returns and invest.
  • Don’t stop investing in mutual funds or a Systematic Investment Plan when the market is falling. It is a good time to invest more as you can get more units with the same amount.
  • Invest regularly and stay invested for the long-term to get the benefits of the power of compounding.

Conclusion Mutual Fund Meaning

Mutual funds have become the most popular and convenient way to put your hard-earned money to use. It is the most suitable investment for the investors as it provides an opportunity to invest in a well-diversified, professionally managed basket of securities at a relatively low-cost.  There will always be ups and downs in the market. Even if your investments are going up or down, it’s important to stay invested and think long term, and this is the best way to get the benefits from mutual funds.  Mutual Fund Meaning

Also Read: Mutual Fund Meaning

One thought on “Mutual Fund Meaning, Definition, Advantages

Leave a Reply

Your email address will not be published. Required fields are marked *

error: Content is protected !!