The moment we hear Mutual Funds the first thing which knocks our minds is - "Mutual funds are subjected to market risks!" This alert is enough for a common man to step back from one of the major the forms of investments which is quite easy and fairly profitable.
Mutual Funds are mostly considered complicated and very often misunderstood by many. However, you will be surprised to know that even the low performing Mutual Funds on an average gives you a return of at least 10%. While for the good ones, it can go up to more than 18%. On the other hand, those secure Fixed Deposits and Recurring Deposits can hardly give a return of 7% and mostly it's less than 6.5 %. Interesting! Isn't it? I suppose now you may be having some curiosity to know more about Mutual Funds. So here we go...
Firstly it's important to understand that Mutual fund companies aka AMCs ( Asset Management Companies) not just invest in stocks or equity but there are ones who are based on real estates, gold and other assets. You may also find plethora of options for ELSS which are the Tax-Saving Funds. So altogether there are many different types of Mutual funds. You need to be smart at picking up the one that suits your requirement. After all, it's smart investment, not gambling!
With the help of an example, let's understand how exactly these Mutual Funds operate.
Say you have to buy a shop of worth five thousand bucks but you have just two thousand. You know the shop has the potential to make substantial profit but you alone can't afford it. So you go to two of your friends, one whose having two thousand and other with one thousand. All three of you agree to buy the shop together and whatever profits comes will be divided among you all in the ratio of 2:2:1. Like this you did not lose the opportunity to buy the shop and earning profit even with a smaller investment. You all got mutual benefits! Similar is the case with mutual funds.
A Mutual Fund company first appoints a Fund Manager to create a portfolio i.e. the list of stocks and assets in which the company can invest. It then invites people like us to contribute our money into their fund. The Mutual Fund company then invests that fund further in the stocks and allots certain number of units to us corresponding to our contribution in their fund. As Mutual Fund makes profit, the value of your units become higher. You also get the freedom to sell your units at any time and Mutual Fund companies are abide to pay you according to the current price of your units. Isn't that cool and relaxing! However, there are a few Tax-Saver Mutual Funds which have a lock-in period of 3 years but there are many without those conditions.
With Mutual Funds you also get the benefit of portfolio diversification. Portfolio diversification refers to the strategy of mixing a wide variety of investments within one portfolio. A diversified portfolio contains a mix of distinct asset types and investments. It’s basically an attempt to limit the exposure to any single asset or risk. You have just one kind of stocks and if that dies then you completely lose. Like you either win all or lose all. However, if you have five different stocks then even if two of them are at loss but because three are making profit, your net becomes positive.
As an individual, when you think of investing in shares, you may find it quite difficult to pick and choose different stocks. You can get tangled in researching only about a few. It truly takes a lot of judgement, intuition, monitoring and experience to pick the right ones. And if you are a person who doesn't get much time to do all that after long working hours at office then probably your tired mind could hardly permit you to dive into the oceans of stocks. This will either lead you to bad decisions or change your mind from investing. One more way out there is that you may seek advice from an experts but that's an overhead. You will simply land up paying their huge consultancy fees before even making any profit.
Fortunately, with Mutual Funds you don't need to worry about all that. They hire reputed experts aka. Fund Managers to do those researches, identify potential stocks and assets and help you invest in maybe more than twenty diverse stocks and assets at the same time. Isn't that amazing!
Are they doing it for free ? The answer is "No". They do charge you for consulting them. When you visit any of their websites, you will be able to spot something called "expense ratio" which is mostly more or less 2%. That refers to the fees which you will be paying to their Fund Managers to manage your stocks. Believe me that is extremely insignificant amount as compared to what you will have to pay if in case you visit them personally.
So with mutual funds, you get following benefits -
1. Small Investment and More Diversity
2. An Expert to manage your asset
3. No large overhead to seek advice
Okay, so mutual funds can pick good stocks for us but there are hundreds of Mutual Funds out there. Now the question comes - "How to pick the best mutual fund ?"
To get the answer to that question please read this next article.
- By Karenite Kell