What is Mutual Fund? Definition, Type, Benefits & More.

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What is a Mutual Fund?

A mutual fund is a collective investment that pools together the money of a large number of investors to purchase a number of securities like stocks, bonds etc.

When you purchase a share in mutual fund, you have a small stake of all investments included in that fund. Hence, by owing a mutual fund, the investor participates in gains or losses of all the companies in the fund. For instance, you can take a mutual fund as a basket of investments. When you purchase a share of that mutual fund, you are buying one share of this basket and hence has an ownership in the all the investments in one such basket.

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Major Types of Mutual Funds:

Open End Funds: The majority of mutual funds in India are open-end funds. These funds are not listed in the stock exchanges are available for subscription through the year. Hence, the investors have the flexibility to buy and sell these funds at any time at the current asset value price indicated by the mutual fund.

Closed End Funds:- These funds are listed on the stock exchange. They have a fixed number of outstanding shares and operate for a fixed duration. The fund is open for subscription only during a specified period. These funds also terminate on a specified date. Hence, the investors can redeem their units only on specified date.

Benefits of Mutual funds:

There are a couple of benefits in investing in a mutual fund.

For example, if there is an investor who wants to invest in stocks but has no time to analyze and create portfolio. Then he can be benefited from the mutual fund. This investor just have to buy a mutual fund and hence, in a single purchase he gets an investment similar to purchasing the entire portfolio of stocks.

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The various benefits of investing in a mutual funds are described below:

  • A simple way to make diversified investment.
    A mutual fund has a number of securities like stocks, bonds, fixed etc already in it’s portfolio. Therefore, buying a mutual fund is a simple way to make a diversified investment. Further, diversification also reduces risk which is an added benefit of buying a mutual fund.
  • Managed by a financial professional.
    The Fund manager or managers actively manage a mutual fund. They try to give the maximum returns to the investors using their professional expertise. Hence, those investors who don’t have time to invest by their own, can get benefits from the expertise of these fund managers.
  • Allow investors to participate in a wide variety of investments
    This is one of the greatest advantage of buying a mutual fund. There are variety of mutual funds available to invest like equity fund (Index funds, growth funds, etc.), fixed income funds, income tax saver funds, balanced funds etc. An investor can easily select the best one which suits his strategy.
  • Investors can sell their mutual funds whenever they want
    There is also a great flexibility to for the investors to sell their mutual funds whenever they want. Please note that it’s suggested to to read the mutual fund prospectus carefully before subscribing as some mutual funds are closed one and have a locking period.

If you want to read about mutal funds from scratch, I highly recommed you to read this book: Indian Mutual Funds Handbook: A Guide for Industry Professionals and Intelligent Investors

Which mutual fund to buy?

After understanding the benefits of a mutual fund, the next question is which mutual fund to buy? There is a variety of mutual funds available in the market which you can find online. These mutual funds have different ratings & rankings and you can choose the suitable mutual fund according to your goal. Here are the two few sites where you can search online:

http://www.moneycontrol.com/mutualfundindia/
https://www.valueresearchonline.com/

Generally, you need to read the prospectus of a mutual fund which gives a wide variety of information about the fund. The fund prospectus has details like fee & charges, minimum investment amount, performance history, risks and other particulars. Here are few example of mutual funds (provided by moneycontrol website):

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Disadvantages of Mutual Funds:

Here are the few disadvantages of buying a mutual fund:

  • Fees and Expenses: There are a couple of possible fees in a fund like management fees, transaction fees, sales fees etc.
  • No Insurance: There is no guarantee of success in the mutual funds. The mutual fund providing companies always states the following in the declaimer in their advertisements:
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  • Poor Performance: On an average, 75% mutual funds are not able to beat the market indices and hence the returns on the mutual funds are by no means guaranteed.
  • Loss of Control: The fund managers are responsible for buying and selling of the securities and you have no say in managing the portfolio. You should also remember that you are trusting someone else with your money when you invest in a mutual fund.

How to make money by mutual fund?

There are basically two ways to make money by a mutual fund –

  1. Appreciation: When the mutual fund appreciates i.e. when the fund grows in value. You can sell the mutual fund at the appreciated value and get good return on your investment.
  2. Dividend Payment: Mutual funds also provides dividends to the investors when they receive the dividend from the companies they own in their portfolio. Please read the prospectus carefully if you are buying a mutual fund for dividend payments. Many mutual fund does not give the dividends or reinvest the dividends in the original fund.

So, that’s all for the basics of the mutual fund. In the next post, I will describe how to buy a mutual fund. In the mean time, if you need any help or have any doubts, feel free to comment below. I will be happy to help.

10 Comments

  1. Am new to stock market and Mutual Funds but i have keen interest in investments.
    Pls help me in buying good funds.
    Which one is better to invest,whether stock market or mutual funds?
    What is the risk factor in both the cases?

    • Hi Ram. I will always suggest to buy stocks of good companies. They always give a decent return. However, investing in stock market will require you to give some of your time. If you can give time, then I will suggest you to go for stocks. If not, then mutual funds is also a good option. If you still have doubts, you can message me on my facebook page: https://www.facebook.com/TradeBrainsOfficial/ I will be happy to help.

  2. Let me know more about equity fund (Index funds, growth funds, etc.), fixed income funds, income tax saver funds, balanced funds etc. And i heard from someone there is a lock in period for some mutual fund. Let me know how to spot out it because i don’t like to go with lock in period.

  3. Sir I need to invest in mutualfund for 20 years plan how to select fund or please guide me and for 20 years plan which is better share or fund please guide

  4. Mutual Funds are the best option for investment after real estate as they give the best returns which is calculated and based on market risks. I will suggest that everyone should invest for their bright future. You can check & start investing with cashiya personal finance the best Personal finance app in India. It helps in managing and buying the right Mutual Fund’s. For more visit : https://cashiya.in

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