Mutual funds do not enthuse many investors because people are yet to get used to them. People have vague ideas about what mutual funds are all about. Often, people feel that they are mentally comfortable with their investments in bank fixed deposits. Besides giving robust returns mutual funds achieve many other benefits.
Mutual funds are diversified in nature: When you buy a mutual fund, your money is combined with the money from other investors; this allows you to buy part of a pool of investments. A mutual fund holds diversity of investments which can make it easier for investors to spread their investments possessing different stocks or bonds. Not all investments perform well at the same time. Government policies, market behavior, Sensex etc keep the stocks move up and down therefore, holding a variety of investments help offset the impact of poor performing stocks, yet, taking advantage of the good ones. This is known as diversification.
They are professionally managed: Mutual funds are managed by professionals called portfolio managers. They decide in which fund to invest the money, and when to buy and sell investments. They keep themselves abreast of market information. They suggest the best plan for their clients with minimum risks involved and maximum returns. The portfolio manager make their clients understand the investment plans and the risks involved in simple language. They are experts and take the responsibility of managing funds well. The portfolio managers are backed by a committed research team, investors are provided with the services of an experienced fund manager.
Mutual funds are easy to buy and sell: Mutual funds are widely available through banks, financial planning firms, investment firms, credit unions and trust companies. You can sell your fund units or shares at almost any time if you need to get access to your money. But you may get back less than you invested depending on the market conditions.
Mutual funds act as emergency corpus: Building an emergency corpus is very important for all. We need funds for emergencies which come suddenly. One can start investing ₹ 2,500 p.m in a liquid fund for say 4-5 years and have an emergency kitty ready when required.
A wide range of funds to choose from: Mutual funds can be used to meet a variety of financial goals. For example: A young investor with a stable income and many years to invest may feel comfortable taking more risk to achieve greater potential return. He may therefore, invest in an equity fund. A middle-aged investor trying to balance risk and return more moderately could invest in a balanced mutual fund that consists of a mix of stocks and bonds. An investor approaching retirement might be less comfortable with risk and more interested in fixed income investments. He may invest in a bond fund.
Beats Inflation: The best part about mutual Funds is that they help investors generate better inflation-adjusted returns without spending a lot of time and energy on it, while most people consider letting their savings ‘grow’ in a bank, they really do not realize that inflation keeps nibbling away its value.
Convenience: Mutual funds are an ideal investment option when you are looking at convenience and timesaving opportunity. With low investment amount alternatives, the ability to buy or sell them on any business day and a multitude of choices based on an individual’s requirement such as funding down payments to buy house, paying fees of children for higher education, marriage in family etc. Mutual funds allow investors to plan their financial goals and investment needs. Once planned, investors are free to pursue their course of life while their investments earn for them. The biggest advantage for any investor is the low cost of investment that mutual funds offer, as compared to investing directly in capital markets. Most stock options require significant capital, which may not be possible for young investors who are just starting out. Mutual funds, on the other hand, are relatively less expensive. The benefit of scale in brokerage and fees translates to lower costs for investors. One can start with as low as ₹ 500 and get the advantage of long term equity investment.
Liquidity: Investors have the advantage of getting their money back promptly, in case of open-ended schemes based on the Net Asset Value (NAV) at that time. In case your investment is close-ended, it can be traded in the stock exchange, as offered by some schemes.
Some common types of mutual funds are:
Money market funds: These funds invest in short-term fixed income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are generally a safer investment, but with a lower potential return then other types of mutual funds
Corporate income fund: These funds buy investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds and high-yield corporate bonds. They aim to have money coming into the fund on a regular basis, mostly through interest that the fund earns.
Equity funds: These funds invest in stocks. These funds aim to grow faster than money market or fixed income funds, so there is usually a higher risk that you could lose money. You can choose from different types of equity funds including those that specialize in growth stocks.
Balanced funds: These funds invest in a mix of equities and fixed income securities. They try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds.
Index funds: These funds aim to track the performance of a specific index such as the UTI Nifty Index Fund, Franklin India Index Fund, ICICI PRU Index Fund etc. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.
Specialty Funds: These funds focus on specialized mandates such as real estate, commodities or socially responsible investing. For example, a socially responsible fund may invest in companies that support environmental stewardship, human rights and diversity, and may avoid companies involved in alcohol, tobacco, gambling, weapons and the military.
Fund-of-fund: These funds invest in other funds. Similar to balanced funds, they try to make asset allocation and diversification easier for the investor.
IDFC Foundation has recently come out with a film ‘One Idiot‘ which is part of the IDFC Foundation’s commitment to educate the youth of India to be financially independent by investing in mutual funds.