Mutual Funds: What Are They And Why They Are Good For You?

Several people invest in mutual funds because they lack the knowledge of making investments in direct equities. Some invest for diversification while others wish to target their long term goals. The reason mutual funds are gaining popularity among retail investors is that they distribute risk across asset classes. To understand the meaning and importance of mutual fund investing, continue reading.

What is a mutual fund?

A mutual fund is an investment vehicle that pools financial resources from investors sharing a common investment objective and invests the capital raised across asset classes and money market instruments to generate capital appreciation. The Asset Management Company running the mutual fund may invest in stocks, bonds, gold, real estate, and company shares. Mutual funds aim to generate income by investing in a diversified portfolio of securities. New investors should be aware of the fact that the performance of a mutual fund scheme depends on the performance of all its underlying assets and securities.

Retail investors can either make a lumpsum investment or invest in mutual funds via a Systematic Investment Plan. Depending on the sum invested and in quantum with the scheme’s existing NAV (Net Asset Value), investors are allotted mutual fund units. For example, if investors invested Rs. 10,000/- in a mutual fund scheme whose current NAV stands at Rs.20/-, they would be allotted 500 units. The value of these units may go up or come down depending on how the scheme performs against market volatility.

Mutual funds carry risks of varying degrees depending on their nature and scheme type. Equity mutual funds are volatile over the short term as their portfolio is constantly affected by fluctuations in the equity markets. On the other hand, debt mutual funds are prone to credit risk and interest rate risk. Before investing in any type of mutual fund scheme retail investors are advised to determine their risk appetite and also seek professional consultation.

What makes mutual funds a good investment option?

Here are a few reasons why investing in mutual funds may turn out to be a good investment decision:

Professional fund management

Investors who are new to mutual fund investing may not have to worry about the fact that they lack investment knowledge. A novice investor too may be able to invest in mutual funds and earn decent capital appreciation. Mutual funds have designated fund managers who monitor the performance of the scheme and take the necessary investment decisions. These expert fund managers may invest in a diversified portfolio of securities and trade them in such a way that the mutual fund is able to generate income.

Adequate diversification

Depending on the nature of the scheme, its investment objective, and asset allocation strategy, a mutual fund may invest across company shares, commodities, industries/sectors, debt instruments, and various other asset classes. Building an investment portfolio with a variety of securities is referred to as diversification. Diversification allows investors to avoid the concentration of risk inherently associated with investing, in any one asset class or industry. This may also allow investors to get exposure to various markets, sectors, and stocks.

Liquidity

Mutual funds offer liquidity. Except for a tax saving scheme like ELSS (Equity Linked Savings Scheme) that comes with a predetermined lock-in period of three years, mutual fund investors can redeem their units at any given point. This flexibility allows investors to easily invest or withdraw from their mutual fund investments. Some schemes like liquid funds even have the option of instant redemption. However, in order to earn maximum capital appreciation, retail investors may have to remain invested in mutual funds for the long run.

Invest smaller sums via SIP

While lumpsum investing requires investors to invest a large sum at the beginning of the investment cycle, a Systematic Investment Plan is a much affordable way to invest in mutual funds. A SIP sum is usually lower than a lumpsum investment sum. This makes investing in mutual funds a much simpler task. In case new investors are not very sure about how much money they should invest in mutual funds, they can refer to the SIP calculator, a free online tool easily accessible to everyone.

No upper limit

Every mutual fund scheme has a minimum investment sum which is mentioned in the Scheme Information Document (SID). However, there is no such thing as ‘upper limit’ which means mutual fund investors can invest as much as their risk appetite allows them to.
Investing in mutual funds is a good option only when investors invest according to their financial goals. Investing without a clear objective may not be an ideal way to invest in mutual funds. Also, these are market linked schemes that do not guarantee capital appreciation. These are a few things that every investor would do well to bear in mind before investing.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.