Mutual Funds: A Beginner’s Guide

We all have different financial goals at different points of time. It could be the education of your child, retirement plans or the marriage of your child. We all look at ways of making our money work and grow faster, not unlike a plant. Taking the analogy further, while we can look after our garden, a gardener does a much better job. The plants benefit with the care and experience of the gardener and free us to do other things. A mutual fund works on this principle. There are many securities available and we do not usually know how the market works. Furthermore we may have small amounts of money available at a given time to invest.

What if a pool of such saved amounts with a common financial goal was done by a group of fund managers? That is the underlying concept of a mutual fund. This pool is invested in shares, securities etc. The income generated by investing in these instruments is then divided in the ratio of investment. Investors benefit without putting in large sums of money, having an experienced fund manager to tend to their fund.

According to AMFI, the advantages of investing in a mutual fund are:

• Professional Management
• Diversification
• Convenient Administration
• Return Potential
• Low Costs
• Liquidity
• Transparency
• Flexibility
• Choice of schemes
• Tax benefits
• Well regulated

Some disadvantages of mutual funds include:

• Hidden fees
• Low liquidity
• Trade execution only at end of day
• Attracts Capital gains tax
• Information about fund not always available

Mutual funds can be categorised according to structure or investment. By structure we mean open ended, close ended or interval schemes.

In open ended schemes the investor can redeem the scheme or buy as many units at any time.

Close ended schemes refer to a limited number of units, therefore buying or selling is restricted by demand and supply of the same.

In an interval scheme, the redemption can happen at pre-determined intervals. It is a mix of the open ended and close ended schemes.

If mutual funds were to be categorised by financial objectives, there are growth schemes, balanced schemes, money market schemes and income schemes.

Growth funds generally invest in equities. This fund will look at high growth opportunities in the medium to long term.

In balanced schemes as the name suggests, investment takes place in securities, preference shares and fixed income securities. The aim is not merely growth but income as well in the long term.