Sunday, March 10, 2013

What is mutual fund

What is mutual fund? How to invest in mutual funds? How safe they are?

     A lot of people, who are interested to invest in share market, keep a distance from the market as they lack sufficient technical knowledge and also because of the possible danger comprised in it.  Many others don’t have much idea about how the share market investment is used in order to get reduced the income tax payment.

     It is not easy for a commoner to get succeeded in the share trading because everyone may not be able to select the best stocks in order to make sure the profit, after reviewing the favorable and unfavorable factors of the market.  Since it is very difficult to forecast the movements of market, it would be a dangerous play as the explosive mines may be paved under the soil anywhere throughout the way.  Here it comes the relevance of mutual funds.  But many people don’t know what are the mutual funds and how one could invest in mutual funds. 

     Here, the fund managers of mutual funds invest the clients deposited money in shares and securities that may fetch good profit.  The profit earned from such investment is divided among the clients as dividend or as the growth in the asset.  In simple words, the money is ours though, it would be experts who usually select the shares and securities that are invested in.  Therefore, the common investor can get rid of the risky responsibilities.

     The activities of mutual fund managers will be professional and they put each steps carefully ahead, as the mutual funds can stand in the market only when it could give an attractive and competitive dividend.  So, the professional fund managers select diversified shares in order to reduce the risk.

     Sometimes, the profit from mutual funds maybe significantly higher than that we could earn from our individual investment in one or two share. One more benefit of mutual funds is that it gives the chance to deposit in the shares of companies that have a high price even if when we have small amount of deposits.   

     For example, a huge amount is needed to buy the shares of the companies like Infosys, Maruti etc from the share market, as the prices of such shares are comparatively high. But we can buy the units of mutual funds that have investment in many such companies with an amount as small as 1000 or 1500 rupees.  In this method, we can be the beneficiary of the profit dividends of such big companies with the small amount of deposit in the concerned mutual funds.

     Mutual fund institutions are the mediators who work in between the share market and the investors.  It is not shares, but the units of mutual funds, that we are buying when we deposit in mutual funds. The price of the units of many mutual funds is as small as Rs 10.  ie, lakhs of such units are sold and the huge amount collected from this process is normally invested in the shares of diversified companies.  Each units show the proportion of the ownership of the particular fund.  The value of such unit is known as the Net Asset Value (NAV) which is the result produced when the total deposit amount is divided by the total number of units.

     NAV is frequently changed in accordance with the variations in the share prices.  The value of deposits can always be calculated by this way. 

     In India, the mutual fund market is grown day by day.  There is chance to deposit in hundreds of funds operated by dozens of institutions.  Therefore, like in the share market, the selection of mutual funds is also getting complicated nowadays.  

     It will work paradoxically against our wish, if we fail to select the funds that have a good track record of growth and dividend payments.  Openly, there is chances of danger even in mutual fund investment as well. 

     Like any other share based deposit schemes, in mutual funds also, there is the chance of loss.  The share holder has his right not only in the profit but also in the loss that may happen for each unit.

     Mutual funds, that investing in shares, bonds, promissory notes and even in gold, are seen nowadays.  The things, like the intention of funds, which sectors they are investing in etc, are mentioned in the offer documents.  Therefore, the investors must be aware about the different mutual fund schemes.

  1. Open ended mutual funds:
These are the funds that can be bought and sold any time from the market.  The trade would be based on the NAV of the trading day. 

  1. Close ended mutual funds:
There will be predefined maturity period, like 5years, 7years etc for this kind of funds. In this kind of schemes, deposits are allowed only at the time of beginning of the fund. After that, the selling and buying are only possible through the listed stock exchanges. Some mutual fund institutions, in special occasions, hold a unit buy back program for the convenience of investors in order to provide them a chance to get out from the fund if they wish.   

Mutual fund schemes are classified to various types based on the investment type, investment intention and the way of the dividends are distributed.  Expect those things in the next post.

Related articles: 
1. What is share market?
2. Inflation indexed bonds to fight back inflation

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