Lesson 5: Mutual Funds – An Intro

If you have come this far, I take it for granted that you are now aware of the basics and raring to go further. At this point, you must realize that you as a person are unique and there may be 1001 reasons why one investment vehicle won’t give you a pleasant ride, while the same may be the best for someone else. But there are a few well tested vehicles that I will review from now on. Still the decision is yours.

A Mutual Fund, as the name suggests, is a trust where many people put in money and this pool of money is managed by a  professional, who on behalf of the people invests the money and the profits/losses are shared (Of course we need to pay the professional too). Since there are many types of investment, there are even more types of Mutual Funds. There are many private players like HDFC-fund, Prudential ICICI, each with a long list of funds and to sort of these hundreds of funds and find the right one for you will take quite some time. Each fund has units that you can buy at a NAV (Net asset value). Say if the NAV is 100 Rs and you invest 2000 Rs in that fund, you will be alloted 20 units of that fund.

Let us see the major types alone. One way of classifying funds is based on where they invest.

   1. Equity – Invest in Shares of Companies in the Stock Market
          * Equity Diversified – Invest in a broad range of companies
          * Equite Sector – Invest only in one type of companies
   2. Debt – Invest in Bonds of Companies and Govt.
   3. Balanced – Midway of the above two

As you must have understood, Equity funds give the highest risk and highest return. Currently some funds are giving in the range of 40-60% per annum too. Debt funds are less riskier and lesser returns.

Another way to classify funds is by the way the profit is shared

   1. Growth Fund – Here the profits are used again for further investments (like compound interest) and so the NAV rises as profits grows.
   2. Dividend – The profit is given to the unit holders on a timely basis

Yet another way to classify funds would be on the basis of when one can invest in them.

   1. Open-ended funds – Open throughout the year. One can invest anytime.
   2. Closes-ended funds – Open only at specific intervals for investment

So if you happen to see details of a fund you can find that it could be “Equity Diversified Open Ended Growth” Scheme or “Balanced Dividend Closed” scheme or any other combination. There may be many gimmicks in the actual name, but you must take care to see the complete details.

Risk and Returns are the two things that you got to note down. For that you can see how the fund had performed in one year, three years, five years and since it was started. You must compare it with similar funds and with BSE/NSE. Also don’t get carried away by the fact that the fund has a great 3 year avg of 50%. It could be due to one 100% and two – 25%. That is not a good sign especially if the – 25 % is from the recent year. So check each year’s performance also separately.

Major Advantages of Mutual Fund

    * You get a professional to manage your fund
    * You can invest in Stock Market with just a few hundred rupees/month
    * You get instant diversification across shares of many companies

Major Disadvantages of Mutual Fund

    * Returns are market linked. So there is a possibility of losing your capital (negative returns)
    * All depends on that one professional. He may not be efficient enough.
    * Cost overhead
    * Sometimes too much diversification can dilute your profits

Situation in India – In India still, people are not very aware of this new type of investment. More are still bound with their love for recurring deposits, fixed deposits and savings account. But Mutual funds give a good method to invest some part of your money in stock markets and give yourself some chance of making greater returns.

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