When you start your investing journey, you’ll encounter many terms that might seem confusing at first. One such term that often puzzles new investors is “mutual funds.” What are mutual funds? How does it work? What are the different kinds of mutual funds? What are the risks involved?. Well, you don’t have to worry because we have your back, helping you navigate through the mutual funds so that you have all of the information you need when you invest in mutual funds.
In this guide, we will give all the information that you need to understand and start investing in mutual funds. But, before we get into what are the different types of mutual funds and the benefits and the risk involved in investing in mutual funds, let us understand what mutual funds are.
What are mutual funds?
In simple terms, a mutual fund is a company that pools money from different investors and invests this money into financial securities such as stocks, bonds, gold, etc. When all of the mutual funds are combined together in one place, that’s called the mutual funds portfolio. The investor buys shares of the mutual funds, which represents the investor’s part ownership of the funds and the income that the mutual funds generate.
So this means that every investor evenly participates in the profits and losses of the mutual funds. What qualities is it of mutual funds that makes mutual funds so popular amongst investors? Now that we have a good explanation of mutual funds let’s take a look at the advantages and disadvantages of mutual funds
Advantages of mutual funds:
- Professionally managed: Investors mutual funds often don’t have the time or the required resources to research or buy the stocks. This is where mutual funds come in, mutual funds are managed by professional money managers who have experience in and the resources necessary to buy, sell and monitor the investments. The fund manager will continuously monitor and rebalance these portfolios as per the scheme’s objectives. So you as the investors don’t need to play as much of an active role, you only have to regularly stay up to date with the stocks.
- Affordability: Another reason why mutual funds and investment are so popular with investors is because you can start investing in them through SIPs as low as Rs.500. For investors it may be more difficult to purchase all of the individual securities that are held by a single mutual fund. You can also cut costs on brokerage fees and commission by choosing the direct plan.
- Risk diversification: You can diversify your investment portfolio with mutual funds, this means with mutual funds you can buy securities and assets across categories such as debt, gold and equity. When you diversify your portfolio, the risk associated with one asset class is countered by another. So when the value of one investment in the portfolio falls, the portfolio isn’t affected because another investment’s value may increase. In simple words, you won’t lose out on the entire value of your investment. Thus, risk diversification is one of the most prominent advantages of investing in mutual funds.
- Low cost: Mutual funds are also known for their low cost. Since it has a huge economic scale, mutual funds have a low expense ratio. Expense ratio shows the annual fund operating expenses of a scheme, expressed as a percentage of the fund’s daily net assets. Operating expenses of the schemes include administrative, management and advertising.
What are the benefits and risks associated with mutual funds?
- Capital Gains Distributions: The value of the securities in a fund may rise over time. When the fund sells a security that has appreciated in value, the fund has a capital gain. At the end of the financial year, these capital gains, after accounting for any losses, are distributed to the fund’s investors.
- Dividend Payments: A fund may generate income through dividends from stocks or interest earned on bonds. This income, after deducting any associated expenses, is then distributed among the fund’s shareholders.
- Loans against mutual funds: Did you know that you can also use your mutual funds as a collateral to take a loan?. Yes, you can. Here while it’s on collateral your mutual funds can still gain returns as long as you don’t default on your payment. Yenmo is a financial institution that provides you with loans against your mutual funds at an interest rate as low as 10.5% with no hidden charges and no credit score check. So your investments can also provide you with a short term loan.
- Increased NAV: Should the market value of a fund’s portfolio increase, the net asset value (NAV) of the fund and its shares will also rise, reflecting the enhanced worth of your investment.
- Understanding Risk: All investment vehicles carry some degree of risk, and mutual funds are no different. Investors should be aware that the securities within a fund can decrease in value, potentially leading to a loss of the invested capital. Additionally, dividend or interest income may fluctuate with changing market conditions.
- Evaluating Performance: While a fund’s historical performance can provide insight into its volatility and stability, it is important to note that past results are not indicative of future returns. A highly volatile fund generally implies a higher level of investment risk.
How to Buy and Sell Mutual Funds?
Investors typically purchase mutual fund shares directly from the fund or through a broker associated with the fund, rather than from other investors. The purchase price is based on the fund’s per-share net asset value (NAV) plus any applicable fees, such as sales charges. Mutual fund shares are “redeemable,” meaning that investors can sell them back to the fund at any time, with payment usually processed within seven days.
Before investing in a mutual fund, it’s essential to thoroughly review the fund’s prospectus. The prospectus offers detailed information about the fund’s investment goals, risks, performance history, and associated costs.
Mutual funds offer an accessible way to diversify investments, benefit from professional management, and begin investing with a relatively modest amount. While these funds can provide opportunities for growth through capital gains and dividend distributions, it’s crucial to recognize that all investments come with risks, including mutual funds. By gaining a solid understanding of mutual funds’ fundamentals, including their benefits and potential risks, you can make informed decisions that align with your financial objectives. Conducting thorough research and careful consideration will always be essential steps toward successful investing.
