Mutual fund is an investment vehicle that pools together funds from investors to purchase stocks, bonds or other securities. An investor can participate in the mutual fund by buying the units of the fund. Each unit is backed by a diversified pool of assets, where the funds have been invested.
A closed-end fund has a fixed number of units outstanding. It is open for a specific period. During that period investors can buy it. The initial offer period is terminated at the end of the pre-determined period. The closed-end schemes are listed in the stock exchanges. The investor can trade the units in the stock markets just like other securities. The prices may be either quoted at a premium or discount. In the open-end schemes, units are sold and bought continuously. The investors can directly approach the fund managers to buy or sell the units. The price of the unit is based on the net asset value of the particular scheme.
The net asset value of the fund is the value of the underlying securities of the scheme. The net asset value is calculated on a daily or weekly basis. The gain or loss made by the mutual fund is passed on to the investors after deducting the administrative expenses and investment management fees, The gains are distributed to the unit holder in the form of dividend or reinvested by the fund to generate further gains. The mutual fund may be with or without a load factor. A commission or charge paid by the investors while purchasing or selling the mutual fund is known as load factor. Frontend load is charged when units are sold by the funds and back-end load is charged when the units are repurchased by the funds. The front-end load factor reduces the units when the investor buys it and the back-end load reduces the investor’s proceeds when he sells the units. Generally, the load factor ranges between 1 and 6 per cent of the net asset value. Sometimes, the fund may not charge both the loads.
Recommended reading: Introduction to mutual funds
The benefits or advantages of investing in mutual funds are:
- Professional management of the investments: Each Mutual fund appoints experienced and professional funds managers and several research analysts, who research before investing, thus adding value to the common investor. These professional constantly keep track of the market changes and news, predict the impact they will have on the investments and take quick decision regarding the adjustments to be made in the portfolio.
- Low costs of Investments: Due to the large amount of funds manages, very low costs accrue per investor. Mutual fund achieves economics of scales in research, transactions and investments. It lowers the cost of brokerage, custodial and other charges.
- Diversification : A common investor has limited money, which he can invest only in a few securities and faces a great risk. If their values go down, the investor loses all his money. Since Mutual Funds have huge amounts of funds to invest, the Fund manager invests in the securities of many industries and sectors; ( called diversifying the risk ). This diversification reduces the risk involved because all the sectors and industries will never go down at the same time. Investors get this diversification by investing a small amount in Mutual Funds.
- Convenient record keeping and administration: Mutual funds take care of all record keeping including paperwork. It also deals with the problem of bad deliveries, broker’s commission etc.
- Various types of Schemes: Mutual Funds offer various types of schemes such as regular income plan, growth plan, equity funds, debt Funds, and balanced Funds. So an investors can select a plan according to his needs.
- Flexibility: Mutual funds offers various schemes, giving the investor the option to shift from one scheme to another at various times depending on his needs, the risk he is willing to take, and the type of return the wants.
- Scope for good return: Mutual fund invest in various industries and sectors, therefore the portfolio gets diversified, resulting in mutual funds generating equitable return.
- Enables investing in high value stocks: The individual investors have less money to invest and cannot invest in high value stocks such as Infosys. With Rs.12000 an investors can purchase only 2 shares of Infosys, which is like putting all his eggs in one basket. Mutual funds have huge amount of funds and can invest in these high value stocks. The benefits from this high value stock can pass on to all the investors.
- Easy liquidity: Mutual fund provides easy liquidity. In the case of open-ended scheme units can be purchased/sold at NAV from/to the mutual fund on any day. In the case of closed-ended funds units are traded on the stock exchange at the market prices, or the investors can repurchase the units from the mutual fund at the prevailing NAV related prices.
- Tax benefits: There are certain schemes that offer tax benefits of the customers. So the investor also tax benefits from mutual fund.
- Provides transparency: Mutual funds keep the customers informed about the competition of all the investments in various asset classes from time to time. During the launch of the mutual fund the offer document provides information on the objective of the funds, cost to be incurred, entry/exist load to be charged to the investor, risk associated with the funds, & detail about the fund mariners, sponsors, members of trust etc.
- Regulated by SEBI: Just like equities, mutual funds are also regulated by the SEBI. This is to safeguard the interests of investor.