Basics of Mutual Funds

Basics of Mutual Funds

Concept

A Mutual Fund is a single portfolio of investments where investors put their money to be managed by an asset management company on behalf of its many investors. This allows each investor access to a professional managed pool of funds.

How
Mutual Funds
Work?

How Mutual Funds Work
Constraints for Individual Investors

Constraints for
Individual Investors

Individuals and corporate investors can invest directly, without professional oversight, in the market. However, they may face the following constraints:

  • Lack of expertise to understand and forecast market trends
  • Lack of time for an in-depth analysis of the various investment avenues or instruments available in the market
  • Inability to accurately monitor the rapidly changing market
  • Inability to diversify by investing in more than one company shares
  • Lengthy procedures for account opening, order placement, execution, delivery, etc.

Factors to be considered before
investing in Mutual Funds

While reviewing your mutual fund options, be sure to evaluate your:

Goals

What do you want from your mutual fund investment? Are you saving for your retirement, your children’s college or investing money for future generations? The answers to these questions can help you narrow down which funds would work best.

Time Horizon

Mutual funds are typically better suited for long term investors. If you think you will need your money in the near future, say within three to five years, then a mutual fund may not be the best option. This is because the return in that amount of time, once removing the cost of fees, may not be enough to make the investment worth it.

Risk Tolerance

Determine how comfortable you are with risk and invest accordingly. Understanding your risk tolerance can help you select funds with strategies and asset allocations that fit this profile.

Benefits of Mutual Funds

Mutual fund investing provides significant benefits, particularly for individuals who prefer to avoid direct involvement in the demanding and time-consuming tasks of researching companies, placing trade orders with brokers, and monitoring stock price fluctuations.

Professional Fund Management

Diversification

Affordability

Tax Benefits

Convenience

Convenience

Return Potential

Transparency

Flexibility

Choice of Schemes

Well Regulated

Investing in Mutual Funds Involves
A 3-Step Process

Step 1

Identify your financial goals and related investment objectives. For example, for a retirement goal, that may be 15 years away, capital growth would usually be the investment objective. But for a retired person, generating regular income could be the objective. Similarly, other financial needs require identifying relevant investment objectives.

Step 2

Choose a mutual fund that suits your investment objective.

Step 3

Make your investment in the chosen mutual fund. You will receive units which will represent your investment in the fund. The number of units you get will depend on your investment amount and the NAV on the day you make the purchase.

Number of units you get = Your investment value / NAV on the day you make the purchase

Mutual Funds Operations

How Does A Mutual Fund Operate?

Each mutual fund scheme adheres to a specific investment objective while investing the money collected from investors. The investor is allotted units for his investment amount depending on the prevailing NAV of the fund.

The value of each unit of the fund is calculated based on the current market price of all the assets held by the fund. This price is called the Net Asset Value (NAV) of the fund.

The total of assets held by the mutual fund at any point of time is called its Assets under Management (AUM). At launch, the AUM is equal to pooled funds collected from the investors. As time passes, funds are invested in assets whose value changes on daily basis reflecting in profits/losses. At the same time, new investments keep coming in, and existing investors redeem or dividend is paid to them.

Risks Involved With Investing In A Mutual Fund?

Like any other market linked investment, mutual funds too are subject to price fluctuation, liquidity, credit risks, etc. Mutual funds however, minimize these risks through diversification and professional management. Performance of mutual funds is dependent on the investments in the portfolio.

Which Funds Are Right For You?

Your optimal mutual fund portfolio will depend on your investment goals, your time frame, and your risk tolerance.

Your Investment Goals

Why are you investing? People invest for a lot of good reasons:

  • Retirement
  • Children’s education
  • Buying a house
  • Helping protect retirement savings against inflation
  • Earning additional current income

Before you invest, you need to ask yourself what you want to accomplish.

Your Time Frame

How much time till you will need the money? By dividing your goals into long and short-term, you will make selecting the right investments a lot easier:

  • Long-term investing gives you the opportunity to go for potentially higher returns by taking on more risk
  • Short-term investing generally means you need to focus on preserving the value of your principal with more conservative investments

Your Risk Tolerance

How much risk are you willing to take? Every investment involves some degree of risk. You have to decide how you feel about risk:

  • If you are looking for higher returns then you may have to invest in equity funds with higher volatility
  • If you are looking to reduce risk then you will have to seek out for income or money market mutual funds that typically offer lower potential returns

The main thing is that you find a comfortable balance between potential risk and potential earnings.

Types of Mutual Funds

Tracking the Performance of Mutual Funds

Tracking the Performance of Mutual Funds

Periodic monitoring of the performance of the mutual fund schemes you have invested in is important as it enables you to take timely decisions in case you need to convert or exit from the fund. There are useful tools which can help you to monitor your mutual fund investments. A Fund Managers Report (FMR) is one such valuable document published by Al Meezan. It is just like a performance report card that indicates the health of the scheme by enlisting details and performance of each of the schemes managed by us. It is usually published on a monthly basis.

FMR is available on the website for investors to view or download. You should periodically refer to this document to keep track of your investments. Click here to read or download our Fund Managers Report.

There are many websites and financial news sources that provide analysis and reviews of mutual fund schemes. These reports can be helpful in understanding the performance of a mutual fund and making informed investment decisions.

Some Costs and Expenses Involved
in Mutual Fund Investing

The mutual fund incurs certain recurring expenses for managing the scheme which is charged to the scheme. Some of these expenses are:

  • Administrative and establishment expenses in proportion to the scheme assets
  • Brokerage and other transaction costs
  • Fund Management fees to the AMC
  • Fees for various service providers involved, such as Trustees, Registrar & Transfer Agents, Custodian and Auditors
  • Scheme advertising expenses and commissions to the distributors
  • Cost incurred on investor communication, account statements, dividend / redemption cheques
  • Fees pertaining to the listing of the scheme
  • Regulator fee

Mutual Fund Returns

Mutual fund schemes offer returns to the investors in the following ways:
  • Dividend and/or Profit Income – A mutual fund may earn income in the form of dividend, or profit on the assets held in the portfolio. The income earned may be distributed by AMC to its unit holders.
  • Capital Gains – The value of any asset or security held by a mutual fund may increase overtime. When a fund sells an asset or security at a price higher than the purchase cost, capital gains are realized by the fund. At the end of financial year, mutual funds distribute capital gains to its unit holders.
  • Increased Net Asset Value – If the market value of a fund’s portfolio increases after the adjustment of expenses and liabilities it is reflected in the increased Net Asset Value of the fund. The higher the net asset value higher is the investment value.
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