Understanding Mutual Funds

The writer is a Delhi, India based Certified Financial Planner CFPCM, conferred upon by the
Financial Planning Standards Board. If you are an Indian resident looking for a financial plan prepared according to your needs & goals, write to her at shruti(AT)richesawait.com

Let’s say you bought one share of Airtel at the beginning of the year for ₹1,000. On the same day, your friend bought one share of Bajaj for ₹1,000. A third friend bought one share of Colgate for ₹1,000.

Now let’s say that at the end of the year, Airtel had grown 15% and your one share was valued at ₹1,150.
Bajaj grew 20%.
Colgate grew 17%.

Great news for friend #2 but not so great for you and friend #3. Even though you all invested the same amount, friend #2’s returns of 20% beat both yours and friend #3’s.

Now, what if all three of you had pooled your money and were entitled to 1/3rd of Airtel each, 1/3rd of Bajaj each, and 1/3rd of Colgate each from the combined ₹3,000? All three of you would have enjoyed a growth of 17.33%!

That is the basic principle behind mutual funds. Because your investment was spread over 3 companies instead of just one, you were able to reduce your risk. Friend #2 may have enjoyed higher returns when the money was not pooled but the scenario may be reversed in year two when his high returns could not be duplicated and your investment beat his.

Mutual Fund is a collective investment tool that pools together money from many investors like you. These collected funds are then invested by a fund manager (aka an investment expert) in various stocks, bonds or other investment vehicles, after conducting thorough research.

The cost of his services is very little as compared to hiring your own personal investment manager. This is because a mutual fund manager manages a large pool of funds, and therefore his fees are shared over a large number of investors. The fund manager and his team constantly monitor the market and invest accordingly to maximize the investors’ capital.

Apart from having a dedicated research team, Mutual Funds have SEBI and other agencies monitoring and regulating them, to ensure the safety of investors’ money.

Mutual Funds allow you to invest a small amount of money, however much you would like (starting from 1000), but still, you can benefit from being involved in a large pool of cash invested by other people. All investors share in the fund’s gains or losses on an equal basis, proportionate to the amount they have invested.

How does a mutual fund work?
When you invest in a Mutual Fund you are allocated X number units. N.A.V (Net Asset Value) represents the value of one unit of your investment after all the fund expenses and management fees are paid. This N.A.V is updated at the end of the day daily.

And you can find out if your investment is doing well or not easily. Whenever you need to check the market value of your investment you simply need to multiply the current N.A.V with the number of units you hold.

Moreover, these units are easily redeemable. It’s like keeping money in a bank account, only it earns better returns in a Mutual Fund.

Every fund has a fixed benchmark to measure the performance. To judge the performance you just need to check how your selected fund has performed against the benchmark set for its measure.

The fund manager’s task is to analyze the market and beat the set benchmark of the fund. This is exactly what you are paying them for.

Of course, there are technicalities involved, but this is the crux of investing in Mutual Fund schemes. Mutual Funds come in many forms, some are sector-based so an Automobile-sector based mutual fund will invest in car-makers like Maruti, Tata Motors etc. Some are Capital based so a large-cap fund will invest only in big companies whereas a small-cap fund will invest in small companies.

There are many benefits to Mutual Funds but it is crucial to examine your own need, goals and risk comfort to determine which Mutual Fund scheme is right for you and to diversify your investment over several different types of funds to ensure all your eggs do not end up in one basket.


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