I came across a folklore about Mahabharat some time ago about how did Draupadi come to have 5 husbands. The story told that Draupadi had asked Shiva for a husband who was noble and strong, skilled with the bow, handsome and wise.
Since no single man could possess all five traits, Shiva gave her five husbands, each with one trait. Just like it’s hard to find all your favorite qualities in one person, it is impossible to find them in one single stock.
The solution here is mutual funds! It is the only investment option that gives you multiple benefits such as higher returns, lower risk, professional management, no lock-in, and low-ticket size.
What is a Mutual Fund?
The concept of mutual funds is very simple. Suppose I am a person who has a small investible amount but I do not know how to invest and generate good returns.
Hence, I need some professional help. But the amount with me is so little that I won’t be able to get any professional help because the professional fees themselves would exceed the returns.
Like me, there are many people who have small amounts available with them but either doesn’t know how to invest or they don’t have resources such as time or information.
In that case, such potential investors come together, collect their money, give it to a professional manager, and ask him to invest it on their behalf so that it can generate good returns and promise to pay him his fees from the return so generated. In order words, they make investments in mutual funds to get a profit.
A mutual fund is a trust that pools the savings of a number of investors who share a common financial goal. It manages the investor’s money by investing in securities to generate a return and charges its fees from that return generated and the remaining return is passed on to the investors.
The only difference between the actual concept and the example given above is that instead of many people coming together and selecting a professional fund manager, the mutual fund collects the money from all the investors in real life.
Types of Mutual Funds
There are different types of mutual funds based on various criteria. But on the basis of securities in which the funds are invested, there are broadly 3 types viz.
Equity Mutual Funds, Debt Mutual Funds, and Hybrid Mutual Funds. In equity mutual funds, the funds are invested in the shares of various companies.
This is suitable for long-term investments to generate higher returns. On the other hand, in debt mutual funds the funds are invested in debt securities of various corporations, government bonds, etc, that carry relatively lesser risk but also have very little potential for returns.
And hybrid mutual funds invest in both equity and debt mutual funds so that you get returns better than debt mutual funds and take risk lesser than equity mutual funds
Benefits of Mutual Funds
- Higher Returns: Equity Mutual Funds have the potential to beat inflation and offer returns higher than FD, Gold, and Real Estate over the long term.
- Lower risks: Since one mutual fund invests small amounts in various securities, your risk reduces because your money is not invested in a single security. This is called as reduction of risk through “Diversification”.
- Professional Management: In mutual funds, the money is managed by professional fund managers who have the experience, knowledge, and skills to manage large amounts of money.
- No Lock-In: Most mutual funds do not have any lock-in period. However, in the case of equity mutual funds, an exit load of 1% is applicable if the units are redeemed within 1 year.
- Low Ticket Size: Minimum amount for mutual fund investments can be as low as Rs.500 p.m.
Risks and disadvantages of Mutual Funds
- Market Risk: Since the amounts are invested in securities, there would always be a market risk howsoever small.
- No Guarantee: There is no guarantee that you would get a minimum of this much return or that your principal is protected.
- Management Risk: There is a risk that the fund manager may not perform well and would not be able to generate the requisite return.
Points to be considered while deciding Mutual Fund Schemes
- AUM of the Mutual Fund and the Scheme: Check the AUM of the scheme and the mutual fund house. It is better to go with a mutual fund having a higher AUM than a smaller one.
- Expense Ratio: Check the expense ratio of the scheme. The lower the expense ratio better it is to invest.
- Experience of the Fund Manager: Consider the professional qualifications and experience of the fund manager in managing the funds as it plays a crucial role in the management of your investments.
- The objective of the Scheme: Decide whether the objective of the mutual fund scheme is in line with your goal other wise you will have to suffer a financial loss.
Investments in mutual funds are an easy and apt way to enter the market. It helps investors grow their wealth without the added stress of additional payments or monitoring the market for gains.
