Introduction to Mutual Funds
In the current scenario of the financial sector, the topic of discussion is a monetary fund or “mutual funds”. mutual funds have become a favorite of millions of people worldwide. The motive of mutual funds is the “safety of the principle”, assured, plus the added benefit of capital appreciation together with the income derived in the form of interest or dividend. Now People prefer mutual funds more than bank deposits, insurance, and even govt. securities because with a small amount, they can get into the investment market. One can own a string of blue chips share through mutual funds. Thus, mutual funds act as a gateway for an ordinary investor to enter into large companies hitherto unfeasible with his small investment.
What is a Mutual Fund:
To define in clear terms, Investment funds are corporations that pool funds by selling their own shares and reduce risk by diversification. A mutual fund collects savings from small investors, invest them in government and other corporate bonds and earn income through interest and dividends in addition to capital gains. It works on the principle of ‘small droplets of water that make a big ocean’. Let’s take a case If a person has Rs. 1000 to invest, it cannot bring too much on its own. But, when it accumulates with Rs 1000 each from many others, then one could create a huge fund large enough to invest in a wide range of stocks and bonds on a large scale and thus, to enjoy the economies of large scale operations. Therefore a mutual fund is nothing but a form of collective investment. It is made by simultaneous or multiple investors who transfer their excess funds to a professionally qualified organization to manage it. To get the excess funds from investors, the fund adopts a simple technique. Each fund is separated into a small portion called units of equal value. Units are allocated to each investor in proportion to the size of his investment. Thus, each investor whether holds a large or small stake in the fund can enjoy a broad portfolio of investments held by the fund. Hence mutual funds enable millions of small and large investors to participate in and get the benefit of the capital market growth. It has emerged as a popular vehicle of wealth creation due to high return, lower cost and diversified risk.
Fund unit vs. share
Just like shares, the price of units of a fund is also quoted in the market. This price is governed basically by the value of the underlying investments held by that fund. At this juncture, one should not confuse a mutual fund investment on units with that of investment on equity shares. Investment in equity shares represents an investment in a particular company alone. On the other hand, investment in a unit of a fund represents an investment in the part of shares of a large number of companies. This itself gives an idea of how safe the units are. If a particular company fails, the shareholders of that company are affected very much whereas the unitholders of that company can withstand that risk using their profitable holdings in other companies’ shares.
Again, investment in equity shares can be used as a tool by speculators and inveterate stock market enthusiasts to gain abnormal profits. These people play an investment game in the stock market based on the daily movement of prices. But, mutual funds cannot be invested for such purposes and the mutual fund is not at all concerned with the daily ebbs and flows of the market. In short, a mutual fund is not the right investment vehicle for speculators. Mutual funds are, therefore, suitable only to genuine investors whereas shares are suitable to both the genuine investors as well as the speculators.
Importance of Mutual Funds
The mutual fund industry has grown at a phenomenal rate in recent years. One can witness a revolution in the mutual fund industry because of its importance to the investors in general and the country’s economy at large.
- Channelising savings for investment:
It serves as a vehicle for the growth of the economy as a whole by offering various schemes suitable for different segments of customers. Many schemes are being offered directly by various funds to cater to their different needs. In the absence of MFs, these savings would have been useless. Thus, the entire economy benefits due to its cost-effective and optimal utilization for efficient development and allocation of scarce financial and real resources in the economy.
- Offering a wide portfolio investment:
Small and medium investors used to spend their time in stock exchange operations with a modest outlay. If they invest in a select few stocks, some may even become submerged. Now, these investors can enjoy an extensive portfolio of investments held by mutual funds. The fund confirms its risk by investing in a large variety of stocks and bonds that cannot be carried by small and medium investors. This is by the maxim “ Not to lay all eggs in one basket”. These funds have a large amount at their disposal, and therefore, they clat in relation to stock exchange transactions. They are in a position to have a balanced portfolio that is risk-free. Thus MFs provide instantaneous portfolio diversification. Risk diversification, which is a pool of savings through mutual funds cannot be derived from an investor’s savings.
- Providing better yields:
The pooling of funds from a large number of customers give the company a large amount of money at its disposal. Because of these large funds, mutual funds can buy and sell them cheaper than small and medium investors. Thus, they can control better market rates and lower rates of brokerage. So, they provide better returns to their customers. They also enjoy economies of large scale and can reduce the cost of capital market appreciation. The transaction costs of large investments are lower than those of small investments. All the profits of a mutual fund are passed on to the investors by way of dividends and capital appreciation. The expenses of a particular scheme alone are charged to the respective scheme. Most of the mutual funds so far floated have given a dividend at the rate ranging between 12% p.a and 17% p.a. It is fairly a good yield. It is an ideal vehicle for those who look for long term capital appreciation.