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What is a Mutual Fund?
Understanding mutual funds
What if you could invest your money and have someone else professionally manage it for you? Services like these do exist, but they come with a requirement of high amounts of capital or money to be invested. What if you could avail such a service, even with a small investment and get the advantage of professional money management? Well, this is possible by investing in mutual funds.
What is a mutual fund?
A mutual fund is essentially a common pool of money in which investors put in their contribution. This collective amount is then invested according to the investment objective of the fund.
The money could be invested in stocks, bonds, money market instruments, gold and other similar assets. These funds are operated by money managers or fund managers, who by investing in line with the specified investment objective attempt to create growth or appreciation of the amount for investors.
For example, a debt fund will have its specified objective to invest in fixed income instruments or products like bonds, government securities, debentures, etc. Similarly, an equity fund will invest in stocks and other equity instruments.
Some common categories of mutual funds are:
Equity funds - funds that invest only in stocks and other equity instruments
Debt funds - funds that invest only in fixed income instruments
Money market funds - funds that invest in short-term money market instruments
Balanced funds - funds that divide investments between equity and debt to create a balance
How is a mutual fund set up?
A mutual fund is set up in the form of a trust, which has a sponsor, trustees, Asset Management Company (AMC) and custodian. The trust is established by a sponsor who is like the promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unit holders. The custodian, who is registered with the Securities and Exchange Board of India (SEBI), holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over the AMC. They monitor the performance and compliance with SEBI Regulations.
The AMC employs professional money managers, having expertise in investing in equity, debt or both, who then invest the collected amount from investors and manage it on their behalf.
The AMC may have several mutual fund schemes with their specific investment mandates. An investor can choose which scheme he or she wants to invest in, based on the given mandate or objective.
All AMCs are governed by a Board of Directors and come under the SEBI (Mutual Funds) Regulations, 1996. The regulator or SEBI has set clear mutual fund regulations and requires all mutual fund schemes of an AMC to clearly spell out the fund’s objectives in its prospectus that an investor must read before he/she invests in a mutual fund.
What is the benefit of investing in mutual funds?
One of the key advantages of investing in a mutual fund is that each investor (even with a small investment) gets access to professional money management and expertise. Also, it would be very difficult for an investor to create a diversified portfolio of investments on his own with a small amount of money. With mutual funds, each investor participates proportionally in the return the scheme generates.
Each unit gets a proportional share of gain (or bears loss) from the fund. There is a portfolio report generated for each investor, which tracks all investments and the returns generated by the mutual fund.
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Make sure you understand the investment objective of the mutual fund before investing.
Know the securities in which the mutual fund investments will be made.
Evaluate the past performance of the fund to understand its average return and associated risks.
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