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Mutual Fund – Basics

Marketlive.in brings you a definitive guide to the Mutual funds. Get to know all that you wanted to know about the mutual funds. Learn about how mutual funds operate and how to choose a fund that suits your requirements.


What is a Mutual Fund ?

You can think a mutual fund as a trust. It is a collective investment from many investors with a common financial goal. Typically, a Fund manager would then invest this money collected from the investors in various other kinds of instruments such as stocks, bonds, debentures, ETF and so on. The Fund manager would be supported by a team of financial experts who advice on the investment decisions. The income that the fund earns collectively from these investments made by the Fund manager, would then be distributed to the original investors who had invested in the mutual fund. The profit that the initial investor earns like this, is called ‘the Dividend’ issued by the Mutual fund.

An Example

To understand it better, let us take an example. Let us say investor A puts his money in a Mutual Fund called ‘X fund’. The Fund manager of this ‘X fund’ would inturn invest this money in other instruments, say in the stock market. During the course of time, if the investments made by the fund manager are profitable, then he passes on a share of the profit to the original investor ‘A’, in the form of dividends.

MF concepts - courtesy AMFI

MF concepts – courtesy AMFI

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How is it different from investing in Stocks / Shares ?

When you invest in Stocks, you would directly trade in the stock market. The stocks that you buy or sell would be either credited or debited directly from your Demat account.

However when you invest in a mutual fund, your Demat account does not get credited with any stocks. Even if the fund manager of your mutual fund invests your money in the stock market. Apart from the stock market, depending on the nature of your mutual fund, your money might be invested in other instruments also such as the bonds, real estate and so on.

The advantage with this approach is that the fund managers are usually a team of financial experts. They are better informed to take investment decisions and thus could make better profits from the investments, a share of which would be passed on to you.

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Do they give guaranteed returns ?

Not all Mutual funds guarantee the returns for the investments made. It depends on the kind of fund that you invest the money in. There are mutual funds which invest only in safer instruments such as the Government Bonds and Debentures. These can assure a guaranteed return.

However, the funds which invest in the Equity market, cannot guarantee the returns. The performance of these equity based funds actually depend on the stock market. If they make losses, then you would also run into a loss.

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How to invest in a Mutual Fund ?

Mutual Funds are usually bought in terms of units. The price that you have to pay for buying a single unit, would be the NAV of that Mutual fund. Note that the NAVs of the funds varies in time, and hence the price of investment also varies.

Systematic Investment Plan ( SIP )

Many mutual funds also allow you to purchase their units through Systematic Investment Plans or SIPs. Through SIP, you can specify a regular amount to be used for purchasing the mutual fund units at specified intervals. For example if you enter a monthly SIP option for Rs.500, it means that every month, you are buying as many units possible for Rs. 500, based on the current NAV of the mutual fund at the time of purchase.

SIP

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How to make profits in Mutual Funds ?

There are two ways that an investor can make profit from Mutual funds. The first one is through the dividends declared by the fund. As explained earlier, when the fund manager sees profit from the investments he has made, a share of the profits is passed on to the investor in the form of dividends.

The second way one can make profit is through Capital Gains. The NAV of the mutual fund either increases or decreases based on the profit or loss that the fund is making through its investments. So if you buy some units of mutual fund at a lower NAV and as time passes, if the NAV of the fund moves up, you can sell them at a higher NAV, making profits. This is called ‘Redemption’.

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What is NAV ?

The NAV stands for Net Asset Value. It is the market value of the assets of the scheme minus its liabilities. Simply put, the NAV of one unit of a mutual fund, represents the price of that the investor has to pay for purchasing it.

The NAV of the fund varies depending on the price movements of the instruments in which the fund has put the money in. For example consider an Equity fund which invests money in stocks comprising the Sensex. The NAV of the fund increases if these stocks gain in a day. Similarly the NAV would decline, if the prices of these stocks fall in the stock market.

If you have purchased some units of a mutual fund at a certain NAV, and in the due course of time, if the NAV has moved up, then you are under profit. You can redeem your units and get back your investment money along with the profits. However if the NAV has declined from your purchase date, then you are under a loss. You can either decide to take the losses by redeeming the units at a lower price or wait for some more time for the NAV to move up.

Click here to view latest NAVs of all Mutual Funds

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What is Entry load and Exit Load ?

Some mutual funds impose an Entry load, while you purchase the units of a Mutual fund. This is usually specified in percentage. This is the amount that you have to pay in addition to the price of the mutual fund, for buying the units. For example, consider a case when the fund specifies an entry load of 2.5%. If you want to invest Rs.100, then you can buy the units only for Rs.97.5, as Rs.2.5 will be charged as the Entry load.

Similarly, the Exit load is the amount that one has to pay to the Fund manager, while exiting or redeeming the units from the Mutual fund.

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How to choose a Mutual Fund ?

Choosing a Mutual fund depends mainly on the amount of risk that you can take in your investment. Some of the equity based funds can promise to give very high returns for your money, but at the same time, might be very riskier, as the performance depends on the Stock market. Similarly, there are funds that invest in safer instruments, but give lesser returns compared to the equity funds.

Hence it would be worthwhile to see the history of the performance of the Mutual fund, before investing in it. You can select a fund, based on the number of dividends that it has declared in a specified period, and the increase in the NAV of the fund over the period. However past performance of a fund, might not guarantee that it will perform in the same way in the future.

You can also ask your agent on the Entry loads and Exit Loads of various funds. You should ensure that you do not end up paying much money for these loads.

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Click here to view latest NAVs of all Mutual Funds


 

 

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