Mutual Funds – What, Why and How
Mutual Funds Sahi Hai – you’ve probably seen or heard this phrase in some place or another – when you’re browsing the internet, driving through the city or even watching television. This article breaks down the 6Ws – well, 5Ws and 1H – what, why, when, who, where, and how, of mutual funds to help you get started with this product.
What is a mutual fund?
A mutual fund is an investment product that pools money from several participants (investors), and uses it to buy a variety of stocks, bonds, and other financial instruments. They are managed by fund managers. The aim of a mutual fund is to generate returns on the money invested, from the investments.
HOW does it work?
Consider this – you and your friends want to get an internet connection that costs 1250 a month. You have 250, your friend A has 500, another friend B has 300, and a third friend C has 200. Together, you can get the connection and so you pool the money to buy it.
Now, how is it decided who uses how much of the connection? Everyone has paid a different sum of money, and you can limit usage for each user depending on their contribution. So, each user will only benefit from what they’ve paid for.
That’s pretty much how mutual funds work too. If you and your friends together invest 1250 and the fund generates a return of 12% for the first year, your share of the return will be proportionate to your investment. Suppose, the money in the fund has increased to 1400 – a gain of 150, you’ll be entitled to 20% of the gain which is 30, while A, B and C make 60, 36 and 24 respectively based on what they’ve invested.
|Total invested: 1250
|% of total investment
|Return on investment
|Gain at 12%
WHY should you invest in mutual funds?
Before I tell you why you should invest in mutual funds, let me tell you why you should be investing in the first place. Your savings aren’t really earning anything at 4%, with inflation at a higher rate. How then can you meet expenses in the future? The answer is investing. When you invest, you give your savings a chance to generate inflation beating returns, and a better opportunity to grow.
So, what are the benefits of mutual funds?
- Earn potentially higher returns: Mutual funds invest in market-linked instruments, and hence can deliver potentially higher returns compared to your traditional products.
- Professionally managed: You don’t need the know-how of how to manage your fund. Your fund manager will take the hard decisions on where to invest and how much to invest, to generate the best returns for your investment. Just invest, sit back and relax!
- Diversification: Your investment is spread across a bunch of securities, so that your risk is minimised. If a stock does badly in a portfolio, its losses can be offset by a good performer. The aggregate of their performance, and your fund manager’s timely calls impact your returns.
- Affordability: You can start investing with as little as 500. A small investment can go a long way, and thanks to the power of compounding, you earn returns on your investment and even its returns.
- Liquidity: Most mutual funds come with no lock-in and can be redeemed easily. Your redemption proceeds get credited straight to your bank account.
- Flexibility: You can choose how much you want to invest, how you want to invest (lumpsum or periodically through a SIP), when you want to invest.
- Options: There’s a mutual fund for every goal. If you want to build an emergency fund, you can invest in liquid funds. If you’d like to build wealth, you have equity mutual funds, if you want stability, you can choose from debt mutual funds. Keep in mind your risk appetite and investment time-frame.
WHO are mutual funds for?
Mutual funds are for everyone! Whatever your goal, there’s a fund that’s just right for you.
WHEN should you invest in a mutual fund?
Now would be a great time to invest in a mutual fund. We’ve always believed that the best time to invest is now. Also, the earlier you invest, and the longer you stay invested, the more opportunities you give your investment to grow.
HOW can you invest in a mutual fund?
You can talk to an advisor and invest in a mutual fund or go direct and invest with asset management companies. It’s easy! All you need is a bank account, and your PAN and you’re good to go.
Get started with your first investment today.