New fund offer (NFO) release: An asset management company can start a mutual fund scheme by launching its NFO. It creates and shares the strategy of the scheme before its launch. Investors can then decide whether and how much they should invest. The NFO units are often priced at a low ticket, hence Rs 10.
Pooling money: After the NFO, Asset Management Companies collect funds from interested investors in order to purchase shares in stocks, bonds and other assets. The units of the fund are also available for sale after it gets operational even to those who did not participate in the NFO.
Investments in securities: A significant determinant of investment will be based on a strategy developed by the fund manager for this scheme. This includes doing thorough research on economies, industries, companies etc. before investments decisions are made into them. After that he purchases those securities which can generate high returns for its unitholders.
Returns: Mutual funds either distribute profits among investors or reinvest them back into the scheme for further growth. If they choose to receive IDCW (income distribution cum capital withdrawal) option as their payout option, investors get their payouts accordingly through direct bank transfer or cheques/Demand Drafts delivered to their registered addresses on record with the AMC/Registrar & Transfer Agents. On choosing a growth option, these gains remain within that portfolio itself and accrue further.
Advantages of mutual funds:
Diversification: The adage ‘don’t put all your eggs in one basket’ is apt for mutual funds because it reduces risk through spreading investment over numerous securities and asset classes. For instance, compared to direct equity investments where you channel funds into individual company shares, equity mutual funds invest in a basket of stocks across sectors, which lowers the degree of risk.
Professional management: Mutual funds are managed by full-time, professional fund managers who have the expertise, experience and resources to actively buy, sell and manage investments. A fund manager continuously monitors investments and rebalances the portfolio accordingly to meet the scheme’s objectives.
Transparency: Each mutual fund has a Scheme Information Document available on its website that can offer you complete information about its holdings, fund manager etc. In addition to this daily NAV publication on AMC site and AMFI site enables investors track their mutual fund portfolios.
Liquidity: You can take back your investments on any business day at the NAV on the day you make your redemption. Therefore, depending on what type of mutual fund you have invested in, you will get your invested funds into your bank account within 1-3 days. However, close-ended funds allow redemption only at the time when the maturity of the mutual fund is reached. Similarly, ELSS mutual funds have a lock-in period of three years.
Tax Savings: Investment up to Rs. 1,50,000 in ELSS mutual funds is eligible for tax concession under section 80C of the Income Tax Act, 1961. Mutual fund investments provide tax efficiency if they are held for longer periods.
Varieties of offerings: There are various alternatives for investing in a range of mutual funds that can suit different needs for investment purposes. For example- Liquid funds cater to investors looking to benefit from debt securities safety and low interest rate riskiness, flexi-cap funds if one wishes stock diversification and solution-oriented mutual funds if one wants investments purposeful for a specific goal like retirement or children’s education among others.
Cost Efficient: Mutual funds are an inexpensive method of investing. The pooled investments from several investors in a mutual fund enable the fund to invest in a basket of stocks and debt securities which otherwise may be out of reach for the ordinary investor or require a higher investment amount. In this way, these pooled investments have the advantages of economies of scale. This is also why their overheads such as brokerage et cetera are outlined as minor forms of fund expenses to the investors. Invest in direct mutual funds through ET money and you will decrease the cost further.
Returns: There is no guarantee for returns from mutual funds as they are subject to market risks. However, equity mutual funds have been known to deliver double-digit returns annually over long term. Compared with bank deposits, debt instruments provide higher interest rates on several occasions. Besides, you can utilize a mutual fund calculator so that you can establish how much money you stand gaining.
Highly Regulated: Securities and Exchange Board of India (SEBI) is the capital market regulator which regulates major aspects related to mutual funds in India. Thus, it should be ensured that mutual funds adhere strictly to certain rules and regulations that protect investors while at the same time mitigate risk, ensure liquidity and promote fair valuation.
Disadvantages of mutual funds:
Exit Load: Most mutual funds usually deduct a service charge deducted at the time of withdrawing an investment within a specified interval (for instance; one year from the date of purchase). It is intended to deter the investor from leaving too soon since it hurts both fund performance and goal attainment by the investor. In contrast, there is no exit load when you buy stocks directly, making it appear even more expensive. However, this has been done in the interest of investors.
Expensive: According to SEBI, maximum expense ratios have been defined for various categories of mutual funds and differ with various sizes of mutual funds. As size increases, expenses tend to fall down. For an equity oriented mutual fund, 2.25% as a percentage of total assets is the highest expense ratio that can be charged. And whether or not the scheme performs well, you must pay for this expense. When compared to another mode of investment like direct stocks for instance, your brokerage cost may be lower than the expense ratio but then again this is being done so as to facilitate convenience and expertise hence it’s all about striking balance.
Over-diversification: One way of diversifying your investments is by investing in mutual funds with many stocks resulting to over-diversification. Not all shares yield good returns always across all portfolios. You may end up buying two similar portfolios held by mutual funds leading to over-diversification. It is recommended that you analyze the mutual fund portfolio before purchasing.
Market risks: Mutual fund investments come with market risk. Diversification does not help in reducing losses caused by various types of securities in the financial markets. Market risks emanate from various macro and micro economic factors. For instance, equities based mutual funds experience high volatility due to changes in stock prices while interest rate risks associated with debt based mutual funds are present because of variations in interest rates and so forth.
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