What are mutual funds — An introduction

Mutual funds — your financial “buffet”

  • Mutual funds are professionally managed by MF “houses” that are also called Asset Management Companies.
  • AMCs collect money from many investors to create a pool.
  • This “pool” is then invested in different types of asset classes like stocks and bonds.
  • Mutual funds are a beginner-friendly product and make it possible for investors (like you) to invest in large companies listed on stock exchanges like the Nifty or Sensex or in bonds and other securities.

How do they work?

Step 1: New Fund Offer (NFO)

  • A new fund offer (NFO) is the first-time subscription offer for a new scheme launched by AMCs.
  • When NFOs are launched, they become a way for AMCs to raise money from the public to buy securities.
  • NFOs attempt to raise funds and are available for a limited time.
  • This means that investors opting to invest in these schemes at the offer price can do so during this stipulated period only.
  • After the NFO period, investors can take exposure in these funds only at the prevailing Net Asset Value (NAV)*

Step 2: Investing money in securities

  • The pooled money is then invested in assets like shares, bonds, and government securities.
  • Fund managers decide the portfolio of the fund based on the fund’s strategy after doing thorough research across companies, industries, and macroeconomy-level analysis that attempts to maximise the fund’s returns.
  • If at any point in time, the selected securities are underperforming, fund managers replace them with better-performing securities.
  • Fund managers also use multiple strategies to choose the securities for a fund to take advantage of the market’s conditions.
  • All these efforts put in by the fund managers give investors access to large portfolios.
  • A fund manager’s continuous efforts in research, monitoring, and rebalancing the portfolio have an impact on the fund’s NAV.
  • Once the fund makes profits, they are either distributed as dividends to investors or invested back into the fund.

Dividends

  • A mutual fund could contain stocks or bonds that generate dividends from time to time.
  • These dividends are then either distributed to investors or reinvested in their mutual fund holdings, thus increasing their NAV.

Capital Gains

  • When a mutual fund’s securities appreciate in value, the fund collects a capital gain. If fund managers then sell the security, these profits (capital gains) are then distributed among investors.
  • If the fund collects capital gains but doesn’t sell the security, it increases the overall NAV. Investors can then decide to either sell their investments or hold on to them.

Are they a good option for early and/or young investors?

  • They allow you to develop investing as a habit and instil financial discipline.
  • They give you access to large and mid-cap funds, which you may not be able to afford by direct investment.
  • They’re professionally managed, saving you the effort of having to conduct your own research into stocks and other securities.

What you DO need to think about is which mutual fund you are choosing.

  1. What is it going to cost you?
  2. How has the fund performed over the last few years?

--

--

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store