by Charumati Haran
“Mutual funds are subject to market risks. Please read the offer document carefully before investing.”
How often have we heard this disclaimer in advertisements? Have you ever wondered what mutual funds are and how they are subject to ‘market risks?’
Mutual funds are related to various types of investments. However the most important ones are stocks and bonds. A stock or share represents part-ownership rights to public and private companies. People with shares receive a part of the company’s profits. Bonds are loans from investors to companies or the government, which accrue interest in fixed installments. Bonds reach ‘maturity’ as they get closer and closer to the date on which the lender must repay the full bond amount. Both stocks and bonds can be traded.
When a person invests in a mutual fund, they are actually joining a group of other people who have also invested in that fund. A mutual fund is an instrument that allows people to pool-in their money with a pre-decided investment objective. The money that is gathered is collectively invested in stocks, bonds and other types of investments. The earnings from the stocks and bonds are then shared out between the investors. This includes earnings from the shares (dividends) and also profits, if the value of a unit increases.
A mutual fund scheme is offered to investors by an approved asset management company (AMC). The scheme is managed by a ‘fund manager’ in accordance with the objective of the fund. People who invest in mutual funds are called ‘unit holders’ as they hold a portion of the mutual fund. The number of units held by an investor depends on the amount of money they have invested. Investors are usually given the option of collecting their earnings directly, or reinvesting it to buy more units.
There are two main advantages of investing in mutual funds:
Of course, mutual funds are supposed to have various disadvantages as well. For one thing, sometimes mutual fund schemes entail lots of additional charges, many of which cannot be understood by the investor. Secondly, a scheme might be over-diversified or diluted. As the investment of each type is small, high returns in one particular investment don’t give a good overall return. For example, say that out of five shares each in 50 different companies, one company does extremely well. However, as there are only five shares allocated in the scheme, the investors can’t maximize their returns. Thus, mutual funds don’t always perform well. This is why there is a statutory requirement for advertisements of most mutual fund schemes to say in their advertisements that the returns are subject to market risks. These risks can be changes in stock prices, interest rates, foreign exchange rates, commodity prices, etc.
The performance of a scheme is judged by its ‘net asset value’ (NAV). It is the market value of the securities held by the scheme. It changes every day with the change in the market value of securities and is often given per unit. NAV is required to be disclosed by AMCs on a regular basis.
There is a huge variety of mutual fund schemes available in the market. They are available for various levels of investment, risk, returns, return expectations, time horizons, etc. (Generally, if an investor is willing to take higher risk, he can expect higher returns and vice versa.) For example, some funds invest mainly in government securities, others invest in bonds, while others still may be focused on specific sectors of industry and so on. This gives flexibility to the consumer who can find a mutual fund scheme which suits their preferred investment strategy and financial goals. For example, you might have heard of the Systematic Investment Plan (SIP). It allows a person to invest a fixed amount regularly. Some schemes also provide tax benefits which makes them more attractive.
Any fund prospectus and offer document must give important details like the fund’s investment objective, risk factors, qualifications and experience of the fund manager and any pending lawsuits and the penalties imposed.
The first introduction of a mutual fund in India occurred in 1963, when the Indian government launched Unit Trust of India (UTI). Until 1987, UTI enjoyed a monopoly in the Indian mutual fund market. The Securities and Exchange Board of India (SEBI) is responsible for formulating policies relating to mutual funds. There is also an Association of Mutual Funds in India with the objective of developing the mutual fund industry.
In the last couple of years, mutual funds have become very popular with investors. Investors get a chance to participate in the market, monitor their investments with limited time and effort and at relatively low cost and risk. Many banks, post offices and individual agents offer various mutual fund schemes. In recent times, SEBI has announced a raft of measures benefitting the mutual fund industry, including provision for a new distributor framework and incentives for reaching out to smaller cities.
“Citibank Mutual Funds FAQs | What Is Mutual Fund, Investment Plans & More | Citibank India.” Citibank Mutual Funds FAQs | What Is Mutual Fund, Investment Plans & More | Citibank India. N.p., n.d. Web. 22 Dec. 2012. <http://www.online.citibank.co.in/products-services/investments/mutual-funds/mutual-funds-faq.htm>
“Mutual Funds Basics.” What Are Mutual Funds. N.p., n.d. Web. 22 Dec. 2012. <http://www.idfcmf.com/mutualfundsbasics.aspx>
“MutualFundsIndia.com - Complete Magazine on Mutual Funds Industry in India.” MutualFundsIndia.com - Complete Magazine on Mutual Funds Industry in India. N.p., n.d. Web. 22 Dec. 2012. <http://www.mutualfundsindia.com/mfbasic.asp>
“Mutual funds are subject to market risks. Please read the offer document carefully before investing.”
How often have we heard this disclaimer in advertisements? Have you ever wondered what mutual funds are and how they are subject to ‘market risks?’
Mutual funds are related to various types of investments. However the most important ones are stocks and bonds. A stock or share represents part-ownership rights to public and private companies. People with shares receive a part of the company’s profits. Bonds are loans from investors to companies or the government, which accrue interest in fixed installments. Bonds reach ‘maturity’ as they get closer and closer to the date on which the lender must repay the full bond amount. Both stocks and bonds can be traded.
When a person invests in a mutual fund, they are actually joining a group of other people who have also invested in that fund. A mutual fund is an instrument that allows people to pool-in their money with a pre-decided investment objective. The money that is gathered is collectively invested in stocks, bonds and other types of investments. The earnings from the stocks and bonds are then shared out between the investors. This includes earnings from the shares (dividends) and also profits, if the value of a unit increases.
A mutual fund scheme is offered to investors by an approved asset management company (AMC). The scheme is managed by a ‘fund manager’ in accordance with the objective of the fund. People who invest in mutual funds are called ‘unit holders’ as they hold a portion of the mutual fund. The number of units held by an investor depends on the amount of money they have invested. Investors are usually given the option of collecting their earnings directly, or reinvesting it to buy more units.
There are two main advantages of investing in mutual funds:
- Diversification: An investor’s money is put in a common fund which is collectively invested in a number of securities. As the money is spread out across different investments, so is the risk. Compare this situation with an investor that invests all their money in shares of a few specific companies. If the prices of those shares falls or the companies go bankrupt, the investor has to suffer a huge loss by themselves. Also, with the help of a mutual fund, an investor gets access to high priced shares which they could not have purchased on their own.
- Professional Management: If an investor tries to ‘diversify’ their investments without mutual funds, they will have to invest in shares of multiple companies, bonds and so on. An investor who invests in a mutual fund has some assurance that their money will be handled by a qualified professional or expert. The fund manager will analyze the economic trends to make informed investment decisions. This makes things easier, more convenient and safer for investors.
Of course, mutual funds are supposed to have various disadvantages as well. For one thing, sometimes mutual fund schemes entail lots of additional charges, many of which cannot be understood by the investor. Secondly, a scheme might be over-diversified or diluted. As the investment of each type is small, high returns in one particular investment don’t give a good overall return. For example, say that out of five shares each in 50 different companies, one company does extremely well. However, as there are only five shares allocated in the scheme, the investors can’t maximize their returns. Thus, mutual funds don’t always perform well. This is why there is a statutory requirement for advertisements of most mutual fund schemes to say in their advertisements that the returns are subject to market risks. These risks can be changes in stock prices, interest rates, foreign exchange rates, commodity prices, etc.
The performance of a scheme is judged by its ‘net asset value’ (NAV). It is the market value of the securities held by the scheme. It changes every day with the change in the market value of securities and is often given per unit. NAV is required to be disclosed by AMCs on a regular basis.
There is a huge variety of mutual fund schemes available in the market. They are available for various levels of investment, risk, returns, return expectations, time horizons, etc. (Generally, if an investor is willing to take higher risk, he can expect higher returns and vice versa.) For example, some funds invest mainly in government securities, others invest in bonds, while others still may be focused on specific sectors of industry and so on. This gives flexibility to the consumer who can find a mutual fund scheme which suits their preferred investment strategy and financial goals. For example, you might have heard of the Systematic Investment Plan (SIP). It allows a person to invest a fixed amount regularly. Some schemes also provide tax benefits which makes them more attractive.
Any fund prospectus and offer document must give important details like the fund’s investment objective, risk factors, qualifications and experience of the fund manager and any pending lawsuits and the penalties imposed.
The first introduction of a mutual fund in India occurred in 1963, when the Indian government launched Unit Trust of India (UTI). Until 1987, UTI enjoyed a monopoly in the Indian mutual fund market. The Securities and Exchange Board of India (SEBI) is responsible for formulating policies relating to mutual funds. There is also an Association of Mutual Funds in India with the objective of developing the mutual fund industry.
In the last couple of years, mutual funds have become very popular with investors. Investors get a chance to participate in the market, monitor their investments with limited time and effort and at relatively low cost and risk. Many banks, post offices and individual agents offer various mutual fund schemes. In recent times, SEBI has announced a raft of measures benefitting the mutual fund industry, including provision for a new distributor framework and incentives for reaching out to smaller cities.
References
“Bond Basics: What Are Bonds?” Investopedia – Educating the World about Finance. N.p., n.d. Web. 22 Dec. 2012. <http://www.investopedia.com/university/bonds/bonds1.asp#axzz2EksvTsN6>“Citibank Mutual Funds FAQs | What Is Mutual Fund, Investment Plans & More | Citibank India.” Citibank Mutual Funds FAQs | What Is Mutual Fund, Investment Plans & More | Citibank India. N.p., n.d. Web. 22 Dec. 2012. <http://www.online.citibank.co.in/products-services/investments/mutual-funds/mutual-funds-faq.htm>
“Mutual Funds Basics.” What Are Mutual Funds. N.p., n.d. Web. 22 Dec. 2012. <http://www.idfcmf.com/mutualfundsbasics.aspx>
“MutualFundsIndia.com - Complete Magazine on Mutual Funds Industry in India.” MutualFundsIndia.com - Complete Magazine on Mutual Funds Industry in India. N.p., n.d. Web. 22 Dec. 2012. <http://www.mutualfundsindia.com/mfbasic.asp>
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