What Is Mutual Fund, How Does It Work And What Are the Benefits?

Aug 10, 2018 10:45 IST 308 views

Mutual funds combine the savings of a large number of investors and then manage it as a single pool of money. The structure is quite simple. A large number of investors pool their savings in a mutual fund and then the mutual fund invests the combined AUM into the particular asset class. For example, equity funds invest in equities, debt funds invest in debt and balanced funds invest in a mix of equity and debt. There are distributors who form an important link. They sell mutual funds on the one side and also advise investors on the other side. For regulating mutual funds there is the umbrella regulation of SEBI and there is a board of trustees to keep a close watch on the functioning of the fund.

Mutual funds proffer some key benefits to the investors. Here are six such benefits and it is only in mutual funds that investors can really get this combination.

Investors Get Access To a Diversified Portfolio

If you have a corpus of Rs.10,000, how many shares can you really buy? You can perhaps buy 9 shares of Reliance, 4 shares of Infosys and regarding Eicher (better luck next time). Mutual funds change this equation. It creates a diversified portfolio of assets and when you buy units of the fund you get a proportionate share of this diversified pool of assets. So you are not exposed to a single stock or a single industry. This automatically manages your risk at a reasonable level. This logic of access to diversification also applies when you are investing in debt funds. Your money is spread across maturities and credit risks.

Mutual Funds Are Wealth Creators in the Long Run

This is more in case of equity funds. When you buy equity funds, your focus should be on time rather than timing. As fund managers select the right stocks and the stocks start showing growth, you can see the NAV multiplying slowly but surely. The best way to create wealth in mutual funds is through systematic investment plans (SIP). They not only give you the advantage of rupee cost averaging but also ensure that yields are maximized over the long run. It is always advisable to opt for growth plans for automatic reinvestment.

There Is a Really Wide Choice in Front of You

The beauty of mutual funds is that you have a truly wide and diverse choice of products in front of you. With equity funds, you can opt for diversified funds, sector funds, thematic funds, index funds, mid-cap funds etc. In the debt category, you can opt for gilt funds, income funds, short-term debt funds, credit opportunity funds, FMPs, liquid funds etc. In the hybrid category, you have a choice of equity dominant funds, MIPs, arbitrage funds etc. While each of these products has their merits and demerits, what matters is that you have a broad choice, very different from plain vanilla products like equities and bonds.

You Funds Will Be Managed By Professionals

Whether you are invested in an equity fund or a debt fund, the one thing you are assured of is professional management by top-of-the-line professionals in the industry. They are supported by analysts, sell-side brokers, dealers, economists who contributing to fine-tuning their decisions. Above all as an institution; mutual funds have access to market flows information, latest news, corporate announcements, corporate access etc. All these factors add up to give you a more professional management of your funds.

Natural Sync With Your Financial Plan

This is an advantage in mutual funds that most investors do not appreciate. When you create your long-term financial plan, you need two things. You need a combination of equity and debt to plan your long-term goals. That is because long-term goals are a trade-off between returns, risk, and liquidity. Mutual funds offer you the best solution. Secondly, it is best to plan your long-term goals through regular investing (SIP approach). Mutual funds permit you to automatically contribute in a phased manner into your investments. In the process, you also get the benefits of rupee cost averaging. In other words, mutual funds naturally sync with the structure of your financial plan.

Offers Liquidity and Transparency

Both are equally important. SEBI regulations insist on a high level of transparency. You have daily NAVs, monthly portfolio disclosures, factsheet analytics etc. Liquidity is a big advantage. Even in an equity fund, you can get the funds into your account in T+3 days. In the case of debt funds and liquid funds, the waiting period is stilled shorter. Except for ELSS, which has a 3-year lock-in, and closed-ended funds; all other funds are fully liquid.

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