What are Mutual Funds

Mutual fund is a financial instrument which pools the money of different people and invests them in different financial securities like stocks, bonds etc. Each investor in a mutual fund scheme owns units of the fund, which represents a portion of the holdings of the scheme. The securities are selected keeping in mind the investment objective of the scheme. Mutual funds are managed by asset management companies (AMCs). AMCs appoint fund managers to manage different mutual fund schemes and ensure that the scheme investment objectives are met. For fund management and other services provided by AMCs, a fee is charged to the investors.

Let us now discuss mutual fund benefits

• Risk Diversification: One of the biggest advantages of mutual funds is risk diversification. Every stock is subject to three types of risk – company risk, sector risk and market risk. Company risk and sector risk are unsystematic risk, while market risk is known as systematic risk. Mutual funds help investors diversify unsystematic risks by investing in a diversified portfolio of stocks across different sectors. Hence mutual fund risk is much lower than individual stocks.
• Smaller capital outlay: Investors will require a large capital outlay to build a diversified portfolio of stocks. On the other hand, since mutual funds work on the basis of pooling of money, mutual fund investors can have the beneficial ownership of a diversified portfolio of stocks with a much smaller capital outlay. Investors can buy units of a diversified equity mutual fund with an investment as low as Rs 5,000/- only or even lower at Rs 500 for ELSS schemes.
• Investment expertise: Mutual funds are managed by professional fund managers who have the desired qualification, expertise and experience in picking the right stocks or other instruments to get the best risk adjusted returns.
• Economies of scale in transaction costs: Since mutual funds buy and sell securities in large volumes transaction costs on a per unit basis is much lower than what retail investors may incur if they buy or sell shares through stock brokers.
• Variety of products: Mutual funds offer investors a variety of products to suit their risk profiles and investment objectives. Apart from equity funds, there are hybrid funds, debt funds, liquid funds and tax savings schemes etc. to suit different investment requirements.
• Variety of modes of investments: Mutual funds also offer investors flexibility in terms of modes of investment and withdrawal. Investors can opt for investment modes like lump sum (or one time), systematic investment plans (SIP), systematic transfer plans (STP) and systematic withdrawal plans (SWP). You can invest in growth option of mutual funds if you want to take advantage of compounded returns over a long investment period or you can invest in dividend option if you want income from your investment.
• Disciplined investing: Mutual funds encourage investors to invest over a long period of time, which is essential to wealth creation. Furthermore, systematic investment plans or SIPs encourage investors to invest in a disciplined manner to meet their various financial goals. Many investors fail to build a substantial investment corpus because they are not able to invest in a disciplined way. Mutual fund SIPs help investors to maintain a disciplined approach to investment. SIPs also help investor take emotions out of the investment process as very often investors get very enthusiastic in bull market conditions, but get nervous in bear markets. It is an established fact that investments made in bear markets help investors get high returns in the long term. By investing through SIPs in a mechanical way, investors can stay disciplined, which is one of the biggest benefits of investing in mutual funds.