Mutual Fund

A mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc. Professionals handle the investments on behalf of the investors who gain enhanced earnings based on their risk appetite.

The portfolio of securities under the fund can be diversified into many types. For example, there could be a combination of stocks and bonds or only equities/bonds. Securities could also be segmented by industries such as tech or energy.

• A mutual fund is a diversified investment scheme whereby each investor owns a partial share of the securities bundle in which typically an asset management company (AMC) invests their accumulated funds.
• It is professionally handled by the fund manager whose job is to ensure optimum returns to the investors as per the fund objectives.
• In return, investors pay certain charges such as the total expense ratio. Charges could vary as per companies but many involve management and transaction fee.
• These funds are available under the systematic investment plan (SIP), where investors contribute funds in the scheme through small fixed amounts payable every month. However, an investor can opt for a lumpsum investment too.
• It is a lucrative opportunity for early investors and middle-and high-income groups as it provides diversification, tax-saving, liquidity, and affordability.

A mutual fund is an investment scheme that holds assets such as stocks/bonds or a combination of two. The portfolio of securities held under the fund comes with a variety to suit the needs of diverse investors. For example, risk-averse investors can opt for a mutual fund account with fixed-interest bonds as they are safer and pay a regular income. Additionally, those with a medium risk appetite can go for a mixture of equities and bonds. If the stock market crashes, your loss can be somewhat offset with the fixed interests of the bonds.

Moreover, the fund helps with affordability as it pools money from a group of investors. Suppose you want to buy an expensive stock priced at $900 per share. For a retail investor, that’s expensive. As an alternative, you can invest $900 in a mutual fund that holds this stock along with many other stocks.

As such, these funds allow middle-income retail investors to be a part of a professionally managed and large-scale investment. They own a part of the investment, just like getting a smaller slice of an apple. Investors get units or shares of the fund in the ratio of the investment made by them. For example, if a fund has total assets of $15000, and an individual invests $750, they will acquire 5% of the total fund value. 

Risks and profits are shared amongst investors. Most funds allow the investor to sell off their shares at any point they want, bringing in liquidity. Also, typically, an asset management company (AMC) undertakes investments with the fund manager overlooking the fund management.

1. A typical portfolio holds between 40-100 stocks depending on the manager’s objective. Investments can be diversified by industries, nations, mid-cap, large-cap stock, etc.
2. Depending on the type of mutual fund, investors could gain dividends, interests, or a combination of both and even capital gains. The income is distributed in the ratio of funds invested by them. The fund manager may decide to reinvest or share the profits out of sales or price appreciation amongst the investors.
3. The value of each unit of the mutual fund is referred to as net asset value (NAV). NAV = (Market value of all securities in the fund - fund expenses)/ total number of units outstanding in the fund
4. Suppose a fund has assets worth $70 million and $5 million expenses. The total number of units held by investors is $2 million. Then, the NAV will be $32.5. If an investor has 100 units, with NAV being $32.5, the total investment held by the investor is $3250.
5. NAVs are updated every day. Investors can compare profitability by comparing NAVs of different months/periods.
6. An investor should always go through the total expense ratio of a mutual fund before investing in it as it reflects its fees. Charges vary with companies, but often, it is a management and transaction fees which is usually between 1-3%. Other charges may include the shareholder fees and early withdrawal penalty if any.
7. The funds are either actively or passively managed. Actively managed funds take trading decisions actively based on ongoing trends and fluctuations of the market. They have higher fees due to more participation. While passively managed funds hold securities of a benchmark index and follow their movement with no active management.
8. Many schemes come with tax advantage. Citing the importance of after-tax returns, few products can help investors gaining the tax alpha. For tax alpha, the individual accounts are handled by an investment manager who knows the long and short-term tax implications.

We can classify mutual funds based on structure and asset class.

1) Based on Structure

• Open-ended funds – They are very common and allow investors to trade units at any point of time at the NAV.
• Close-ended funds - Involves issuing shares to the general public only once during the IPO. Once listed on the exchange, they can be sold only to another investor and not to the fund. Shares are traded at a premium or discount of the NAV.
• Unit Investment Funds - where trusts issue shares only once upon their creation with the overall portfolio also remaining unchanged. They don’t come with the services of a professional fund manager and have a restricted life span although investors can sell anytime.

2) Based on Asset Type

• Money Market Funds: They pool money towards short-term low risk assets such as certificates of deposits and treasury bills.
• Equity Funds: They could contain value stocks, growth equity, small-cap stocks, mid-cap stocks, large-cap stocks, or a combination of all.
• Bonds Funds: These products are made of bonds giving interests as an income. Fixed interest bonds are low risk, giving stable earnings. Those with floating interests allow higher chances of profits but through greater risks.
• Balanced Funds: They are a combination of equities and bonds, usually in the 2:3 proportion, to balance the risk and return profile of the product.
• Index Funds: Such a fund traces the change in the value of its underlying market index like S&P 500.
• Speciality Funds: Here, the securities belong to a specific segment like healthcare, automobile, technology, energy, industrial or telecommunication.

There are many mutual fund companies and websites with screeners, advisors and calculators to help investors prepare an ideal portfolio along with their expected returns. BlackRock, Vanguard Group, and Fidelity Investments are some highly reputed mutual fund companies.

Distinct metrics judge the ranking of funds. For instance, Invesco Premium Portfolio is a famous money market fund. Its minimum investment requirement is $1000, 0.18% expense ratio and a 7-day yield of 0.11%.

For years, these funds have helped young individuals, especially those with limited or fixed income, to make bigger gains due to their affordability and the option of SIPs. Besides, open-ended funds provide greater liquidity to the investors while many bring down the tax liability.

Professionals who understand the market’s nerve and hold rich experience can help grow funds exponentially. Additionally, investors hold regulatory assistance as the industry is appropriately regulated. For example, the law requires funds to file shareholder reports regularly with the SEC.

However, there are also certain disadvantages. Investors should invest in a portfolio after ensuring it is suited to their risk appetite and financial goals. A balanced portfolio helps in offsetting losses. Otherwise, it could bring in heavy losses as mutual funds are prone to market fluctuations, lowering average returns of even actively managed funds that customize trading as per trends.

In 2018, even the actively managed funds saw massive losses in the US owing to interest rates hikes and economic slowdown. Sometimes, the fees charged from the investors is relatively high, lowering earnings. Besides, some funds have lock-in periods where early withdrawals result in penalties.

An exchange-traded fund is a combination of securities which is tradable on a stock exchange. They track an index or commodity, etc. An index fund tracks an underlying benchmark market index value like the S&P 500.

FAQs

This has been a guide to Mutual Fund, its definition, investment objective and why people invest in mutual funds. You may also have a look at these articles below for further details -

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