What are mutual funds?
A mutual fund is an instrument where the money is pooled from different investors and invested in different kinds of securities such as Equity, Debt, etc. Let’s get this with a simple example when you were young and probably you had played cricket. Now your group saw a nice cricket bat in the shop and would like to buy it. The price of the bat was 1000 Rs. , as you all were kids and don’t have that much capital.
Suppose you are a group of 10 friends and decided that if each of you contribute Rs. 100, it can be bought and within each of your budgets. This is a similar concept of mutual funds and how it works. Now compare this with retail investors who wanted to invest in Equity or Debt, but due to lack of capital, they remain deprived of that. In a mutual fund, fund managers collect investment capital from such investors and invest in different kinds of securities.
Should I choose the Equity Portfolio or Mutual Fund?
There will be a query in your mind that if I have sufficient capital to invest on my own then whether I should directly invest in equity or through a mutual fund. The answer to this depends on whether you have sufficient knowledge about the market, it’s working, can read financial statements, remain updated related to market news and events, etc.
If you have and knowledge and time to manage all these then you can go for an Equity portfolio. But if you don’t have sufficient time for all these then you should prefer a mutual fund. Because in Mutual fund, all these work such as research, management, handled by fund managers. They are experienced professionals in the field of investment, so you can be assured that your capital is in safe hands.
Is a mutual fund good for me?
There are three kinds of people in the stock market one is traders, the second are investors and the third is a combination of both. Traders are those who are expecting a certain amount of return on their capital per day, week, or month. The second one is investors who look for long-term investment, minimum 2-3 years. The third one is those who do both, suppose they have 1 lakh capital to invest, 60-70% of the capital they will put for long-term purposes like Mutual fund, an Equity portfolio, etc., and the rest 20-30 % for trading purpose.
If you belong to the first category i.e of pure traders then probably you will not be happy with the comparative returns you get in mutual funds than in trading. But it is advised to keep a certain part of your trading capital in long term. Because in the end trading is all about speculation and there is an equal probability of profit and loss.
But if you keep a certain portion of your investments for the long term, volatility in the market will bother you the least. Yes even in long term there is a risk but less comparative to trading. If you are a full-time trade then you can go for a mutual fund if you don’t have sufficient time to handle it on your own.
They are 4 subclasses of investors:
- Investors with a finance background and high capital.
- Investors with a finance background but limited capital to invest.
- Investors who are not from a finance background but with good capital to invest in.
- Investors who are not from a finance background and have limited capital to invest.
Except for the first subclass, all the other three classes need some guidance to invest their capital. Because even if they have a finance background and have all the knowledge but not sufficient capital to directly invest in equity or debt then a mutual fund is best for you. In other cases where you don’t have a finance background and knowledge then you definitely need guidance for your investments and mutual fund managers can be the best choice.
Are mutual funds safe?
The answer to this question depends on the context in which you are asking. If you think in terms of fraudulent activities such as they will run away with all your invested capital then this hardly happens. Because the mutual fund is registered with SEBI and they are highly regulated. It is a lot different from Ponzi schemes and chit funds that offer quick returns and then get disappear with all your invested capital.
So be assured in terms of trust. The second context is in terms of returns, and end up making a loss. Yes, we cannot ignore the probable risk in the stock market but it all depends on the kind of scheme and fund manager you choose. So in terms of returns if you invest for a longer time horizon then you can get more than expected returns with other tax benefits that you don’t get in indirect investment.
Difference between ETF and mutual fund
ETF and the mutual fund have many similarities but a little bit different from each other in terms of functionalities.
|Mutual Fund||Exchange-Traded Fund (ETF)|
|Actively and Passively managed||Actively and Passively managed|
|Closed-end fund trade on exchanges but only at the specified time||Available to trade on exchange for the whole time during market hours|
|High charges for fund management, especially for actively managed fund||Fewer charges, just brokerage fees involved|
|There are two kinds of funds i.e open and close-ended||There are major three kinds of ETF i.e Open-ended funds, Unit investment trust, Grand trusts.|
|Can have higher returns than benchmark index in an actively managed fund||Returns are mostly the same as benchmark index returns.|
Pros And Cons of Mutual fund
- Managed by experienced fund managers
- Risk reduction due to diversification
- Dividend benefits.
- High expense ratios and charges
- Overtrading by management
- High lock-in periods.