By investing in mutual funds, you are investing in a basket of common stocks or bonds or a mix of stocks and bonds, and other securities that are held within the fund. Mutual funds offer an alternative way to invest in the stock market.
Most individuals are not interested in, do not have time for research and most importantly, are not qualified to research on their own before investing in individual stocks. Therefore, they go for a mutual fund.
By putting your money in a mutual fund, you are buying the skills and expertise of the fund manager to invest and reinvest on your behalf in financial assets for a better return.
Before knowing how to make money by investing in a mutual fund, it’s better to understand what a mutual fund is, its pros and cons, and what are the types of mutual funds that exist in the market.
What is mutual fund
A mutual fund is created by an asset management company (AMC) to pool investments from various individuals, institutional investors, and other groups of investors to purchase various securities.
They hire a fund manager who invests money contributed in stocks, bonds, a mix of stocks and bonds, money market instruments, and/or other financial assets as per the terms dictated by the fund’s prospectus.
In other words, a mutual fund is a collection of financial assets such as stocks, bonds, and other securities. It’s one of the most popular investment options for the common man.
When you invest in a mutual fund, you own the share of the mutual fund. This means you are buying shares in a portfolio of stocks, bonds, money market instruments, and/or a mix of these financial assets held by the mutual fund.
The value of your mutual fund goes up and down as the value of financial assets such as stock and bonds in the fund rise and falls.
In the simplest terms, a mutual fund can be considered as a basket of investments that hold stocks or bonds, money market instruments, or a mix of stocks, bonds, and other financial assets.
What is Net Asset Value or NAV
Each investor in a mutual fund owns units, which represents a portion of the holding of the fund. Income or loss generated from it is distributed proportionately among its investors by calculating net asset value or NAV.
Price of each share/unit of a mutual fund is called its net asset value or NAV.
To calculate the net asset value, you need to take the total value of all the securities the mutual fund owns and divide it by the total number of shares or units. The total value of all the securities is automatically calculated at the end of each business day.
Therefore, NAV is always calculated at the end of the business day. You can place an order for mutual fund shares at any point during the trading day, but the order will be executed based on the NAV at the end of each business day.
Your share in a mutual fund entitles you to a proportional owner of shares in the underlying securities of the fund. Your proportional ownership will reflect in the price of each mutual fund share, known as NAV.
Important benefits of mutual fund
Here are the most important benefits of a mutual fund;
- Allows you to diversify across a variety of financial assets that you may not have carried in your portfolio as an individual investor.
- A cost-effective way to gain access to professional money management.
- Offers benefits of professional stock picking and portfolio management. As an individual investor, you need not do your own research to select stocks for your portfolio. Which means, they have a team of professionals researching and analyzing investments on your behalf.
- You as an individual investor are not required to analyze financial statements, financial markets, and economics to be a successful investor. On your behalf, the mutual fund manager will do the research and necessary analysis before investing.
- Offers many different categories and types to help you invest based on your investment strategy and financial goals.
- You need a very small amount to get started.
Major disadvantages of mutual fund
Like any other investment option, a mutual fund has its own disadvantages. Here are a few most important disadvantages;
- Having a professional fund manager to help you and other participants in buying and selling of stocks and other investments come with a cost. You will be charged a percentage of your investment to help cover all the costs including the money paid to these fund managers. Before investing in a mutual fund, it’s always better to be aware of these costs.
- Change in fund managers may impact the performance of the mutual fund. Therefore past performance is no guarantee of future returns.
- Even though it’s professionally managed by experts and well-diversified, mutual funds inherent market risk. In case of an economic downturn or recession, based on the market performance, the value of the underlying assets in it can possibly decline, which might result in negative returns.
To invest in a mutual fund you need to do your own research before investing. If you don’t have investing skills, we suggest you take professional help. A financial expert can help you determine your best asset allocation and investment strategy to align with your financial goals and risk tolerance.
Many investors prefer to go for index funds. It’s a type of mutual fund where the money is invested in all the stocks of a particular index regardless of how they are performing. Index fund fees are generally low in comparison to other managed mutual funds.
Index funds are popular due to low expense ratios, low turnover ratios and managers’ tenure is not important.
What you should do before investing
It’s always advised to do your own homework before getting into the stock market and investing in a mutual fund.
You need to know your investment goals and risk tolerance level, and accordingly choose 4-5 mutual funds with better individual asset allocation to invest.
The asset allocation that suits your financial goals is another most important thing you must look at. Based on your risk tolerance level, you can pick mutual funds which are the mix of investment assets such as stocks and bonds.
You will also find aggressive and conservative funds in the mutual fund industry. If you have a high tolerance for risk, you can go for an aggressive fund otherwise a moderate or conservative fund is better.
If you want a higher return, then you must accept a higher risk.
Remember, while selecting a mutual fund you need to keep in mind that past performance doesn’t guarantee future results.
Types of mutual fund
Mutual funds can be divided broadly into two types and categories: stock funds and bond funds.
Stock funds can be further divided into subcategories. Some are based on the market capitalization, few are sector-specific and others.
Here is a list showing types of mutual fund that exist in market;
- Equity fund – It’s also known as stock funds. In it, fund managers focus only on corporations that are publicly traded in the stock exchange.
- Large-cap – Based on the company’s market capitalization, money contributed by investors, invested in listed large-cap stocks.
- Mid-cap – Invested in stocks of listed mid-sized companies.
- Small-cap – Invested in stocks of listed small-sized companies.
- Growth fund – Investments are restricted to innovative listed companies that are rapidly expanding at a rate faster than the market average.
- Value fund – It focuses on companies that the market has overlooked. Which means available at a price lower than the intrinsic value.
- Blue-chip fund – Invest in fundamentally well-established companies.
- Exchange-traded funds – Invest in stocks to match an index such as BSE Sensex, NSE nifty, and S&P 500. Also known as passive mutual funds. The main objective is to match the performance of a particular index. They offer low cost and return at par to the market.
- Actively managed funds – Managed by a dedicated fund manager who decides when and which security to buy and sell. It gives you professional stock picking and portfolio management. The goal is to beat the market.
- Open-ended funds – Units are open for purchase or redemption through the year.
- Close-ended funds – units are purchased only during the initial offer period but can be redeemed at specified maturity date. These funds are often listed in stock exchanges to provide liquidity to buyers.
- Interval-funds – These funds have both open-ended and close-ended features. Fund management can offer to repurchase units from existing unitholders at different intervals during the fund tenure.
- Money-market funds – invested only in liquid instruments such as treasury bills.
- Balanced or Hybrid funds – invested in a mix of asset classes such as stocks, bonds, liquid instruments. But, in general, a stock proportion is always higher than bonds and other assets.
- Emerging market funds – investments are made in developing countries that show good prospects for the future.
- Bond Funds – Invested only on securities that return a fixed income such as corporate bonds, money market bonds, and government bonds.
You as an individual investor don’t control which stock to be bought and sold in the stock market and what kind of dividend to seek out. It’s decided by the fund manager.
There is no age when one can start investing in a mutual fund. You can start investing any time once you start earning and saving. Based on your investment horizon, financial goals, and safety, you may choose different schemes suitable for different purposes.
Before getting into investing, we suggest you have an emergency fund ready to take care of your living expenses in case of any emergencies.
Mutual Funds are subject to market risk. Please read all scheme related documents carefully before investing.