Mutual funds are an ideal choice for most investors. They are simple to use and offer a number of advantages

Mutual funds combine the savings of a large number of investors and manage it as a single pool of money. Instead of investors worrying about which stock or bond or commodity to invest in, professional fund managers do the job.

Simply put, a mutual fund is a financial intermediary, set up with an objective to professionally manage the money pooled from investors at large. By pooling money together in a mutual fund, investors can enjoy economies of scale. Mutual funds are set up as Trusts and they appoint Asset Management Companies (AMC) to manage the funds. Each AMC operates a number of schemes suited to different types of investment needs.

For the individual investor who does not have much time to study and research investments himself, mutual funds are one of the best option for reaping the benefits of different types of investments with minimum effort and at a lower cost. In most funds, it is possible to start investing with as little as a thousand rupees or even less. Also, unlike many other investments, mutual fund investments are ‘liquid’¹. ‘Liquid’ means an investment can generally be withdrawn without much delay. When an investor wants to withdraw money from a mutual fund, it is generally possible to do so at short notice and receive the redemption proceeds within a few business days.

Many Types of Funds

There are many types of funds with a wide range of risk levels, profit potential, and type of fund management. Funds that invest in equity have the potential to provide higher returns but with a higher risk. At the other extreme, there are funds that invest in short-term bonds having a potential to give relatively lower returns than equity funds but at a much lower risk. There are plenty of intermediate funds as well, which offer varying degrees of risk and returns. For example, hybrid funds, as the name indicates, are a mix of equity and bonds. They combine some of the characteristics of both.

Then there are gold funds, which are a way of investing in gold without having to buy physical gold. They allot mutual fund units which hold physical gold as the underlying security. These funds give almost the same returns as physical gold would have fetched² but without the hassles of storage, purity checks, liquidity risk, etc. There are also international funds that invest in foreign securities without investors having to contribute in foreign currency³. As per the mechanism, domestic mutual fund companies either invest in foreign securities directly or invest in an overseas mutual fund which further invests in these securities.

Investors, however, need to keep an eye on the track-record of individual funds, their fund managers and the fund companies, to make the right decision.

Benefits of Mutual Funds

Instant and easy diversification: One of the basics of safe investing is to spread your money across different investments. Mutual funds are an easy way to do this. Mutual funds help to spread the money across a large number of investments - not just across different companies but also across different sectors and sizes of companies, thus providing safety.

Professional research and investment management: Investing is a lot of work. There are hundreds of companies to track and their prospects could change without warning. While you could do it all yourself, you may not have the time or the resources to spare. Mutual funds employ professional, whole-time investment managers and research staff. Their cost and effort gets shared among all the investors in a fund thus providing economies of scale.

Variety: There are mutual funds available for every kind of risk level and suitable for every kind of time horizon. No matter what kind of investment you want, there is likely to be a variety of fund that suits you.

Convenience: You can easily invest as well as withdraw from mutual funds. Investments can be made by filling up a simple form or even online with direct debit from your bank account. Similarly, redemption proceeds can be credited directly into your bank account within a few business days. If you go directly to buy shares to have a diversified set, you will need a lot of money to do so. However, through a mutual fund, you can invest in a diversified set of stocks for as little as a few thousand rupees. And what’s more, you can invest (or redeem) in small batches as well. Same is the case with international stocks which would be very expensive and complex to purchase at an individual level.

Transparent, well-regulated industry: Mutual funds are obligated by law to release comprehensive data about their operations and investments. All funds release NAVs (Net Asset Value) daily and their complete portfolio every month. SEBI regulates the fund industry very closely and is constantly refining the applicable rules to protect investors better.

Summary

Mutual funds are an easy way for investors to gain benefits of investing without having to do much research or analysis. Mutual funds also offer diversification, convenience, tax efficiency as well as many other benefits. There are mutual funds available for a wide variety of investing needs. For the investor who does not have much time to study and research investments himself, mutual funds are the best option to reap the benefits of different types of investments.

Notes:

1. Applies to open ended funds
2. Before transaction charges, loads and expenses
3. Investors would need to bear the currency risk as all contributions would be in INR

This article is dated December 1, 2014. Information contained in this article is not a complete representation of every material fact and is for informational purposes only. Regulatory/ taxation details, if any are provided on a best effort basis and are as per the existing laws and subject to change from time to time. The recipient is advised to consult an advisor/ tax consultant prior to arriving at any investment decision.