What is Mutual Fund? Best Mutual Fund Investing Guide [2023]

What is Mutual Fund?

“What is mutual fund?” is the traditional but most important question for you as a beginner. Many times you think of starting an investment in mutual funds. But there is always a fear in your mind whether a mutual fund is right for investment or not ??

Regardless of how often you see mutual fund advertisements. You are afraid that there will be loss of money! But trust me. If you invest for a long period of time (7-8 years or more), your loss may occur in rare circumstances, otherwise you will always be in profit.

Because it is mutual fund. It has its own specialty. It is not possible that investment is discussed and there is no mention of mutual fund.

In the last nearly three decades, most new investors are taking their first steps in the world of stock market through mutual funds. These funds have been the most popular means of investment in the US and many other developed countries for nearly 40 years.

But Indian investors had their first major experience in 1986. At present, there are about 44 registered fund houses in India together offer more than 2500 mutual fund schemes. Whereas in United States, this number is more than 9500.

( Source: https://www.statista.com/ )

More than 50 million Indian investors have invested their money in mutual funds. And this number is increasing daily. Stock prices are also not untouched by their impact.

Let us now come to the main topic and understand “What is mutual fund?”

Mutual Fund Definition

There is no universal definition of a mutual fund. Many types of investment companies are included within this term.

“A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets.”

Source : Investopedia

Mutual Funds Meaning

In simple words, a mutual fund is an investment company that invests money collected from its shareholders, usually in shares, debt securities, money market securities or a combination of these.

You can suppose it like a fund, which is nothing but a collection of money from various sources to serve a predetermined task. So you now be clear that mutual funds do not have their own money which is invested in stock market securities. They only invest investors’ money.

For example, when you invest in an equity fund, you do not buy these shares yourself in the stock market. This is done by mutual funds for you. In the stock market, you are free to buy any share of a company as you wish. But when you invest your money through a mutual fund, the whole decision to buy or sell shares is made by the mutual fund manager.

Mutual funds are known as ‘investment trusts’ in the UK. But it is known as a ‘mutual fund’ in the United States and India.

How the Mutual Fund Works?

In my previous post on “How to invest in the stock market“, I have mentioned that before investing in the stock market you should decide to do it yourself (DIY) first or not. You should be clear that investing in mutual funds is not done as DIY. It is a type of alternative investment.

Many people do not have the time or experience to invest in the stock market. Mutual funds provide a great opportunity for them. The concept behind mutual funds is quite beneficial for small investors. Mutual funds give them access to a well diversified portfolio from the securities market at a very low cost.

Mutual funds are a means of investing money. The rate of interest from the bank on any of your investments is usually less than the rate of inflation. Therefore, it is not very appropriate to keep your extra money in the bank, as the value of money decreases over time.

But initially you should choose to invest in Mutual Fund due to not having a good understanding of the stock market. All this does not mean that mutual fund investment is only for small investors.

Many financial institutions such as banks, insurance companies adopt mutual funds as regular investments because they know that ‘what is mutual fund?‘

What is Mutual Fund? Craving for Best Mutual Fund Investing? 

Image source: https://corporatefinanceinstitute.com

The above image is enough to illustrate your concept of how mutual funds work.

Understanding What is Mutual Fund with Example

To understand what is mutual fund let us suppose you want to buy a stock from the stock market that is very expensive and its price is Rs 20,000 per share. If you have only 1000 rupees for investment, then you will not be able to buy it from the direct stock market.

But if you invest this money in a mutual fund??

Suppose 99 more investors like you give one thousand rupees each to a mutual fund, then 1 lakh rupees will be deposited with the fund manager. This total deposited amount with Mutual Fund is called Asset Under Management (AUM).

Now, the fund manager comfortably buys the above 5 shares and distributes a total of five shares as a unit among all 100 investors. In this way, you are called Unit Holder. The price of this unit is called Net Asset Value (NAV). Which you can track daily and assess the profit and loss on your investment.

Net Asset Value ( NAV )

The most important criterion of economic health of mutual funds is – NAV. With its help, you can assess the performance of your fund. And also, it can be compared with funds of other companies.

It is defined as

NAV = {( market value of total assets + Cash balance ) – operational  and other expenses } ÷ Total number of shares

What is Mutual Fund Structure?

The mutual fund structure is almost the same everywhere. The structural arrangement of mutual funds (in India) can be divided into 4-tiers for better understanding. Here, Asset Management Company (AMC) or investment managers are at the central point.

Promoters or sponsors are at the top level who appoint trustees to float a mutual fund and establish an AMC, which in turn appoints a custodian or depository, registrar, transfer agent and auditor. Investors in this hierarchy are at a lower level, but the most important among them, also known as unit holders.

All the participants involved in this business are under control of a government institution like SEBI in India. A sponsor or promoter applies to get registration in SEBI first to start mutual fund activities.

SEBI gives a certificate of registration if the sponsor meets the required criteria of experience, profitability, positive net worth, etc. Now, under the provisions of the Indian Trust Act, 1882, the sponsor appoints a trustee and forms a board of trustees.

All board’s trustees should be independent individuals, not associated with the sponsor in any way. Trustees play an important role in maintaining trust among investors/unit holders of mutual funds.

The Board of Trustees appoints an Asset Management Company (AMC) to carry out the daily activities of mutual funds. A private limited company or a wholly owned subsidiary of a public limited company or even a joint venture may be as a AMC.

You should note that an AMC is appointed to manage a mutual fund scheme, while the trustees are there to manage them. The work of a depository (before the custodian) is to maintain records of ownership of securities in dematerialized form such as bank records.

Unit holders’ applications are accepted and processed by registrar, and updating AMC in regard of subscription and redemption. Transfer agent issues and redeem units whenever necessary.

What is Mutual Funds’ Source of Income

There are mainly three types of income sources, which investors can earn from mutual funds. They are:

• Capital Appreciation-profit from selling investment when price rises, (or loss from selling investment when price falls ),
• Dividends – from the revenue income on investment in shares or bonds (depends upon fund managers decision based on profitability of the fund, market conditions) and
• Bonus Issues– it is rarely given.

What is Mutual Funds’ Fees?

Mutual funds charge fees according to their expenses.These fees are mainly two –

1. Annual Fund Operating Fees – They charge an annual operating fee of 1 to 3% of the funds under management. This includes advisory fees and administrative costs collectively called expense ratios.
2. Shareholders’ fees – This includes sales fees, commissions and redemption fees. An investor pays it at the time of purchase (also known as front-end load or entry load) or by selling the fund (back-end load or exit load).

An additional fee is also charged as a penalty for early withdrawal to investors or the holding is sold off before a specific time has passed. Many of these fees are sometimes waived by mutual funds to attract investors.

What are Mutual Funds Advantages?

Mutual funds have many advantages that attract you to invest in them. Some of them are as follows –

1. Easily Available – Mutual funds are available to all by nature. Since a mutual fund is a service as well as a product. So you can buy it very easily.
2. Inherited Diversification – For retail investors, mutual funds provide diversified investment opportunities that are not possible in stock market investment. For example, if you even invest a total of  rupees 4000 in SBI Blue chip fund(G), then the fund gives you the benefit of diversification by investing these money in at least 30 or more different companies.
3. Money Managed by Experts/ Professionals– By investing in mutual funds, you hand over your money to trained and experienced professionals. This is especially beneficial for those who neither have the understanding to invest correctly in stocks nor the financial ability to buy the services of expensive brokers or advisors. Investors who are unable to take time for fundamental analysis or technical analysis of fluctuations of companies and stock markets also get a lot of convenience by investing in mutual funds.
4. Adequate Liquidity –  Mutual funds are liquid enough. You are able to invest for a short time. And you can sell it whenever you want. You can add or subtract more funds to your portfolio.
5. Wide Varieties Available – You get varieties of funds here and can buy what you find suitable for you.
6. Transparency due to Well Regulation – Since all mutual funds operate under regulatory like SEBI. Hence there is no lack of transparency here. Yes, there is a need – all investors should read the documents given by the mutual fund before investing. Especially the parts which are printed in very fine letters.

What are Mutual Funds Disadvantages?

Mutual funds also have some drawbacks, which you should know.

1. Lack of Handsome Returns – People who invest in mutual fund generally shy away from taking more risk. But where there is no risk, there is also no return. So many times these funds miss the opportunity to earn big profits. One reason is that the fund is under pressure to show good results in a short time.
2. Too much Diversification – Sometimes some companies in the market or the single industry are performing more well. But due to more diversity in mutual funds, they are not able to do much good.
3. High cost – A good portion of the investors’ investment goes into a lot of fees charged by mutual funds. Then this investment is not very beneficial.
4. No Control of Unit Holders – You have no control to invest your money according to you even in worst cases.
5. Too Difficult to Compare Funds – Due to the large number of funds, their comparative study is not easy. Which causes difficulties in investing.
6. Mediocre Return – Investment in mutual funds does not guarantee success. And there is no insurance for depreciation in their price.

How to Buy Mutual Funds 

You can invest in mutual funds in three ways. They are-

1. By Direct Visiting to the Branch of Fund House– In any city, you will find branches of many fund houses. You will find all the necessary documents there. Please read all the documents carefully before keeping your signature and submitting the required documents (PAN Cards, Identity Cards etc).
2. By Calling Sales Professionals/Agents at Your Home – They will help you in every way but may charge a small commission for their services.
3. By Online – Nowadays, it has become the most popular method. You can invest your money directly by visiting various fund houses / distributors’ sites or apps. For your convenience, here, I am giving only few website addresses:

• Money Control
• Groww 

What is Mutual Fund Type?

Several types of mutual funds based on structure and asset class are now available to investors. Some of them are Equity Funds, Debt Funds, Hybrid or Balanced Funds, etc. Which I will discuss in detail in the next post.

Conclusion

I personally like to work in the stock market as a DIY. Because the possibilities of learning increase. But everyone’s circumstances are different. Many of us do not have time to learn investing. Therefore, mutual funds are a very good option for them. So keep investing.

Please give your valuable suggestions and feedback. Mention what you would like to read next. By the way, I have written about passive income ideas, which you will like.