Mutual Fund Fundamentals for New Investors

Introduction Dear friends most of you have heard about the equity or shares. but amongst very few of you have traded. and very rare have made money out of it. Am I right? So today I am going introduce you one more avenue of investment.

Which will give you joy of both worlds, equity and debts. for those people who have burnt their hands in the fire of equity jungle (forest) and all those who want earn super normal returns from equity markets as well as debt markets. individually and combined both. Yes, you guessed me right, I am talking about mutual funds, today I will explain what is mutual fund, how do they work and benefit us, what are the different types of mutual funds etc.

What is a mutual fund?

Mutual fund is a vehicle to mobilise money from investors, to invest in different markets and securities, in line with the objectives agreed upon, between the mutual fund and the investors, in other words, through investment in a mutual fund, a small investor can avail of professional fund management services offered by an asset management company. Dear friends now whatever I explained in above sentences you might not have understood.

Am I right?

So let me explain in very local and native style. for example we all stay in a very remote and rural village. Each one has his own economic standards, and all of them decide to go on tour to a destination which is far away. some of them have seen that destination. but don’t have funds to go there on their own.so what they do? they collect and contribute to expense of the tour. and take the benefit of group efforts and funds, and all of them save their money. I hope you understood the basic principle of the concept of mutual fund.

Role of mutual fund

Mutual funds perform different roles for different constituencies. The primary role is to assist investors in earning an income or building their wealth, by participating in the opportunities available in various securities and markets.

It is possible for mutual funds to structure a scheme for any kind of investment objective, thus the mutual funds structure, through its Various schemes, makes it a possible to tap a large corpus of money from diverse investors. Therefor mutual funds offer schemes. In the industry, the words “funds” and Scheme are used inter-changeably. various categories of schemes are called “funds”.in order to ensure consistency with what is experienced in the market.

The money that is raised from investors. ultimately benefits governments, companies or other entities, directly or indirectly, to raise moneys to invest in various projects or pay for various expenses. As a large investor, the mutual funds can keep a check on the operations of the investee company, and their corporate governance and ethical standards. The projects that are facilitated through such financing, offer employment to people, the income they earn the employees buy goods and services offered by other companies, thus, overall economic development is promoted.

The mutual fund industry itself, offers livelihood to a large number of mutual funds, distributors, registrars and various other service providers. Higher employment, income and output in the economy boost the revenue collection of the government through taxes and other means. when these are spent prudently, it promotes further economic development and nation building. Mutual funds can also act as a market stabiliser, in countering large inflows or outflows from foreign investors. mutual funds are therefore viewed as a key participant in the capital market of any economy.

Why mutual fund schemes?

Mutual funds seek to mobilise money from all possible investors. Various investors have vivid investment preferences.in order to accommodate these preferences, mutual funds mobilise different pools of money. each such pool of money is called a mutual fund scheme.

Every scheme has a preannounced investment objective. when investors invest in mutual fund scheme, they are effectively buying into its investment objective.

How do mutual funds operate?

Mutual funds schemes announce their investment objective and seek investments from the public. Depending on how the scheme is structured, it may be open to accept money from investors, either during a limited period only, or at any time.

The investment that an investor make in a scheme is translated into a certain number of units in the scheme. Thus, an investor in a scheme is issued units of the scheme. Under the law, every unit has face value of Rs.10.the face value is relevant from an accounting perspective. the number of units multiplied by its face value (RS.10)is the capital of scheme. its unit capital.

The scheme earns interest income or dividend income on the investments it holds. further, when it purchases and sells investments, it earns capital gains or incurs capital losses. these are called capital gains or realized capital losses as the case may be. Investments owned by the scheme may be quoted in the market at higher than the cost paid. Such gains in values on securities held are called valuation gains. similarly ,there can be valuation losses when securities are quoted in the market at a price below the cost at which the scheme acquired them. Running the scheme leads its share of operating expenses Investments can be said to have been handled profitably.

If the following profitability metric is positive. (A)+ interest income (B)+ Dividend income (c) + realized capital gains (D)+ valuation Gains (E) -realized capital losses (F)- valuation losses (G) – scheme expenses When the investment activity is profitable, the true worth of unit goes up. When there are losses, the true worth of units goes down. the true worth of the unit of scheme is otherwise called as NET ASSET VALUE(NAV) of the Scheme.

When a scheme is first made available for investment, it is called a new fund offer. during the NFO, investors may have the chance of buying the units at their face value. post NFO, when they buy into scheme, they need to pay a price that is linked to its NAV. The money mobilized from investors is invested by the scheme as per the investment objective committed. profits or losses, as the case might be, belong to the investors. the investor does not however bear a loss higher than the amount invested by him.

Why mutual funds for beginners?

Professional Management at minimal cost Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. there are several aspects to such professional management.

Investing in line with investment 0bjective, investing based on adequate research, and ensuring that prudent investment processes are followed.

Affordable portfolio diversification Units of scheme give investors exposures to a range of securities held in the investment portfolio of the scheme. Thus, even a small investment of Rs.100 in a mutual fund scheme can give investors a diversified investment portfolio. An investor ensures that all the eggs are not in the same basket. consequently, the investor is less likely to lose money on all the investments at the same time. thus diversification helps reduce the risk in investment.in order to achieve the same diversification as a mutual fund scheme, investors will need to set apart several lakhs of rupees. instead, they can achieve the diversification through an investment of less than thousand rupees in a mutual fund scheme.

Economies of scale The pooling of large sums of money from so many investors make it possible for the mutual fund to engage professional managers to manage investment. individual investors with small amounts to invest cannot by themselves, afford to engage such professional management. Large investment corpus leads to various other economies of scale. for example, costs related to investment research and office space get spread across investors.

Further, the higher transaction volume makes it possible to negotiate better terms with brokers, bankers and other service providers. Thus, investing through mutual fund offers a distinct economic advantage to an investor as compared to direct investing in terms of cost saving.

Liquidity Investor in a mutual fund scheme can recover the value of the moneys invested, from the mutual fund itself. depending upon the structure of the mutual fund scheme. this would be possible, either at any time, or during specific intervals, or only on closure of the scheme.

Tax Deferral Mutual funds are not likely to pay tax on the income they earn. If the same income were to be earned by the investor directly. than tax may have to be paid in the same financial year. There are many tax benefits of investing mutual funds.

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