A mutual fund is a popular investment vehicle that lets you pool your funds with other investors and equally invest in stocks, bonds, or other important securities. They are managed by professional fund managers, who decide which securities to buy and when to sell them. With a mutual fund, investors get exposure to a variety of investments in funds and any income they generate. In this article, we will explore everything about mutual funds, how they work, their features, types, risks and a lot more.
Table of Contents
Key Features of Mutual Funds
The following are the key features of mutual funds.
- Diversification: Mutual funds give you access to a variety of assets to spread risk. They protect investors from poor performance of any single asset by holding a range of different investments.
- Liquidity: This is the most appealing feature of mutual funds. Investors can easily convert their investments into cash. This helps investors to buy or sell shares on any business day at the fund’s current net asset value (NAV).
- Professional Management: Mutual funds are managed by professional fund managers. They have experience in selecting and monitoring the investments. They decide where to allocate the pooled funds based on the fund’s objectives, market analysis, and economic conditions.
- Low Cost: Since a mutual fund buys and sells large amounts of securities at a time, its transaction costs are generally lower than what you would pay as an individual investor.
Types of Mutual Funds
Based on their structure and investment goals mutual funds can categorised into different categories, as listed below.
- Equity Funds: Equity funds majorly invest in stocks and they aim for long-term capital growth. They are generally defined by the size of the company they invest in like small cap, mid cap, or large cap.
- Debt Funds: Commonly referred to as fixed-income funds, debt funds invest primarily in bonds, debentures, government securities, and many more fixed-income instruments. In comparison to equity funds, these funds have relatively less risk associated with them.
- Hybrid Funds: These invest in a variety of asset classes, mainly between equity and debt. The purpose is to provide a diversified portfolio wherein the mutual fund gets them both capital growth as well as income generation. Therefore, there is not much risk involved.
How Do Mutual Funds Work?
Mutual funds work by pooling capital from multiple investors and then using that sum to buy securities based on the objective of the funds. These are the following steps involved in mutual funds.
1. Fund Creation
A mutual fund is created when an asset management company (AMC) designs a fund with an objective, strategy, and risk profile.
2. Pooling of Funds
The fund manager uses the contributions made by all investors to create a single fund, which is used to invest in a diversified portfolio of assets. Investors have access to investments they might not be able to afford on their own.
3. Portfolio Management
The manager will select the portfolio’s securities based on the mentioned objective of the fund. For example, he might focus on growth stocks in an equity fund, or else a bond fund invests in government or corporate bonds.
4. Management and Control
The fund manager actively manages the portfolio by buying, holding, or selling securities. By doing this they try to maximise returns while ensuring the investment strategy is consistent with the desired objectives of the fund.
5. Returns to Investors
Investors can earn returns in various ways. They include the dividends, capital gains and net asset value (NAV) appreciation.
Risks of Investing in Mutual Funds
The following are the risks involved in investing in mutual funds.
- Market Risk: The value of a mutual fund’s assets can fluctuate with market conditions, leading to potential losses.
- Management Risk: Poor decisions by the fund manager can adversely affect returns.
- Fees and Expenses: High expense ratios can reduce the overall returns, especially in actively managed funds.
Conclusion
Investment in mutual funds is a great investment option; they combine the benefits of diversification and professional management. Mutual funds minimise the risk that they experience when they invest directly in individual securities. The rise in investment platforms like a mutual fund app has made it easy for investors to manage their portfolios and view the performance or trade from anywhere. Investments, however, manage the risks and costs. Therefore investors must choose funds to suit the budget with their financial goals.