Understanding Mutual Funds in Five Minutes
Everybody talks about mutual funds, but what exactly are they? Are they like shares in a company, or are they like bonds and fixed deposits? Will I lose all my money in funds or will I become an overnight millionaire? Big questions that get answered in just five minutes. Read on.
What is a mutual fund?
A mutual fund is a pool of money that is invested according to a common investment objective by an asset management company (AMC). The AMC offers to invest the money of hundreds of investors according to a certain objective - to keep money liquid or give a regular income or grow the money long term. Investors buy a scheme if it fits in with their investment goals, like getting a regular income now or letting the money accumulate over the long term. Investors pay a small fraction of their total funds to the AMC each year as investment management fees.
How many categories of mutual funds are there in the market?
There are three broad categories of funds in the Indian market - money market, debt and equity. A money market fund invests in short-term government debt paper and is good for parking money for the short term since the principal is safe, returns better than a bank deposit and liquidity high. Debt funds invest mainly in debt instruments like government securities, corporate and institutional debt paper. They are also called income funds since people buy them for their income needs. Equity funds invest in the stock market and suit long term investors who want capital appreciation. Commodity, property and gold funds are yet to come into India.
Why should I invest in a mutual fund?
Investors with small portfolios may not have the necessary expertise nor get the required diversification across debt and equity products. For example, equity-seeking investors may find their money insufficient to buy enough companies to spread their risk. Or they may find funds insufficient to spread between cash, debt and equity products. Mutual funds offer a way out, for as little as Rs 1,000, an investor can approach most schemes and get well-diversified portfolios, across product classes and instruments. The money is invested by market experts. As markets mature, funds begin to customise products according to need. It is possible to match a unique need to a specific scheme from a fund house.
How do I make money?
There are two ways of making money from a mutual fund - through dividend or through capital appreciation. Suppose a mutual fund scheme collects Rs 500 crore by selling units priced at Rs 10 each. The fund invests this in stocks and debt paper. After a year the corpus grows to Rs 600 crore. This Rs 100 crore can now be distribted amongst the unit holders as dividend. Or it can remain in the fund, taking the net asset value (NAV) or the price of the unit, higher, to say Rs 12. Investors can now sell and realise a gain of Rs 2 per unit or can hold on for future appreciation. (We are ignoring costs in this simplification) But
3Everybody talks about mutual funds, but what exactly are they? Are they like shares in a company, or are they like bonds and fixed deposits? Will I lose all my money in funds or will I become an overnight millionaire? Big questions that get answered in just five minutes. Read on.
What is a mutual fund?
A mutual fund is a pool of money that is invested according to a common investment objective by an asset management company (AMC). The AMC offers to invest the money of hundreds of investors according to a certain objective - to keep money liquid or give a regular income or grow the money long term. Investors buy a scheme if it fits in with their investment goals, like getting a regular income now or letting the money accumulate over the long term. Investors pay a small fraction of their total funds to the AMC each year as investment management fees.
How many categories of mutual funds are there in the market?
There are three broad categories of funds in the Indian market - money market, debt and equity. A money market fund invests in short-term government debt paper and is good for parking money for the short term since the principal is safe, returns better than a bank deposit and liquidity high. Debt funds invest mainly in debt instruments like government securities, corporate and institutional debt paper. They are also called income funds since people buy them for their income needs. Equity funds invest in the stock market and suit long term investors who want capital appreciation. Commodity, property and gold funds are yet to come into India.
Why should I invest in a mutual fund?
Investors with small portfolios may not have the necessary expertise nor get the required diversification across debt and equity products. For example, equity-seeking investors may find their money insufficient to buy enough companies to spread their risk. Or they may find funds insufficient to spread between cash, debt and equity products. Mutual funds offer a way out, for as little as Rs 1,000, an investor can approach most schemes and get well-diversified portfolios, across product classes and instruments. The money is invested by market experts. As markets mature, funds begin to customise products according to need. It is possible to match a unique need to a specific scheme from a fund house.
How do I make money?
There are two ways of making money from a mutual fund - through dividend or through capital appreciation. Suppose a mutual fund scheme collects Rs 500 crore by selling units priced at Rs 10 each. The fund invests this in stocks and debt paper. After a year the corpus grows to Rs 600 crore. This Rs 100 crore can now be distribted amongst the unit holders as dividend. Or it can remain in the fund, taking the net asset value (NAV) or the price of the unit, higher, to say Rs 12. Investors can now sell and realise a gain of Rs 2 per unit or can hold on for future appreciation. (We are ignoring costs in this simplification) But