Why or Why not Mutual Funds?

What  is Mutual Fund?

A mutual fund is an investment vehicle where many investors pool their money to earn returns on their capital over a period. This corpus of funds is managed by an investment professional known as a fund manager or portfolio manager. It is his/her job to invest the corpus in different securities such as bonds, stocks, gold and other assets and seek to provide potential returns. The gains (or losses) on the investment are shared collectively by the investors in proportion to their contribution to the fund.

Why should you invest in Mutual Funds?

The primary benefit of investing in a mutual fund is that you get exposure to a variety of shares or fixed income instruments. For instance, if you wanted to invest Rs. 1,000 directly in stocks, you would probably get only a share or two. If, on the other hand, you invested through a mutual fund, you would get a basket of several stocks for the same amount.

These are the main types of mutual funds:

 

·         Stock (equity) funds typically carry the greatest risk alongside the greatest potential returns. Fluctuations in the stock market can drastically affect the returns of equity funds. There are several types of equity funds, such as growth funds, income funds and sector funds. Each of these groups tries to maintain a portfolio of stocks with certain characteristics.

 

·         Bond (fixed-income) funds are typically less risky than stock funds. There are many different types of bonds, so you should research each mutual fund individually in order to determine the amount of risk associated with it.

 

·         Balanced funds invest in a mix of stocks, bonds and other securities. Balanced funds (also called asset allocation funds or hybrid funds) are often a “fund of funds,” investing in a group of other mutual funds. One popular example is a target-date fund, which automatically chooses and reallocates assets toward safer investments as you approach retirement age.

 How mutual funds make you money

 When you buy into a mutual fund, your investment can increase in value in three ways:

1.     Dividend payments: When a fund receives dividends or interest from the securities in its portfolio, it distributes a proportional amount of that income to its investors. When purchasing shares in a mutual fund, you can choose to receive your distributions directly, or have them reinvested in the fund.

2.      Capital gains: When a fund sells a security that has gone up in price, this is a capital gain. (And when a fund sells a security that has gone down in price, this is a capital loss.) Most funds distribute any net capital gains to investors annually.

3.      Net asset value: Mutual fund share purchases are final after the close of market, when the total financial worth of the underlying assets is valued. The price per mutual fund share is known as its net asset value, or NAV. As the value of the fund increases, so does the price to purchase shares in the fund (or the NAV per share). This is similar to when the price of a stock increases — you don’t receive immediate distributions, but the value of your investment is greater, and you would make money should you decide to sell.

How to invest in mutual funds?

 Decide whether to go active or passive

Your first choice is perhaps the biggest: Do you want to beat the market or try to mimic it? It's also a fairly easy choice: One approach costs more than the other, often without delivering better results.

Actively managed funds are managed by professionals who research what's out there and buy with an eye toward beating the market. While some fund managers might achieve this in the short term, it has proved difficult to outperform the market over the long term and on a regular basis.

Passive investing is a more hands-off approach and is rising in popularity, thanks in large part to the ease of the process and the results it can deliver. Passive investing often entails fewer fees than active investing.

Calculate your budget

Thinking about your budget in two ways can help determine how to proceed:

How much do mutual funds cost? One appealing thing about mutual funds is that once you meet the minimum investment amount, you can often choose how much money you’d like to invest

Which mutual funds should you invest in? Maybe you’ve decided to invest in mutual funds. But what initial mix of funds is right for you?

Generally speaking, the closer you are to retirement age, the more holdings in conservative investments you may want to have — younger investors typically have more time to ride out riskier assets and the inevitable downturns that happen in the market. One kind of mutual fund takes the guesswork out of the “what's my mix” question: target-date funds, which automatically reallocate your asset mix as you age.

Mutual fund pros and cons

Still trying to decide if mutual funds are for you? Here are the pros and cons.

 Pros

These are the primary benefits to investing in mutual funds:

·         Simplicity. Once you find a mutual fund with a good record, you have a relatively small role to play: Let the fund managers (or the benchmark index, in the case of index funds) do all the heavy lifting.

·         Professional management. Active fund managers make daily decisions on buying and selling the securities held in the fund — decisions that are based on the fund's goals.

·         Affordability. Mutual funds often have a required minimum amount as low as RS 100, but several brokers offer funds with lower minimums, or no minimum at all.

·         Liquidity. Compared with other assets you own (such as your car or home), mutual funds are easier to buy and sell.

·         Diversification. This is one of the most important principles of investing. If a single company fails, and all your money was invested in that one company, then you have lost your money. However, if a single company within a mutual fund fails, your loss is constrained. Mutual funds provide access to a diversified investment without the difficulties of having to purchase and monitor dozens of assets yourself.

Cons

 Here are the major cons of mutual funds:

·         Fees. The main disadvantage to mutual funds is that you’ll incur fees no matter how the fund performs. However, these fees are much lower on passively managed funds than actively managed funds.

·         Lack of control. You may not know the exact makeup of the fund’s portfolio and have no say over its purchases. However, this can be a relief to some investors who simply don’t have the time to track and manage a large portfolio.