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A mutual fund is simply a financial intermediary that allows a group of investors to pool their money together with a predetermined investment objective. The mutual fund will have a fund manager who is responsible for investing the pooled money into specific securities (usually stocks or bonds). Mutual funds are one of the best investments ever created because they are very cost efficient and very easy to invest in (you don’t have to figure out which stocks or bonds to buy).
Mutual funds work by pooling money together from many investors. That money then gets used to purchase stocks, bonds and other securities. Because mutual funds invest in a collection of companies, they offer instant diversification (thus lower risk) to investors. Mutual fund investors share in the fund’s profits and losses.
You have probably heard of index funds and ETFs before, which are two types of passive-investing mutual funds. There are also, however, actively managed mutual funds. These are mutual funds that are run by fund managers who choose your investments and buy/sell securities based on the fund’s goals.
Actively managed mutual funds usually aim to beat the market (though outperforming the market regularly over the long term is hard to do), while passively managed index funds, for example, work to simply match the market’s performance.
With mutual funds, investors have a lot of choices to try and grow their money between stock funds (“equity funds”), bond funds (“fixed-income funds”) or funds that offer both (“balanced funds”). Within these categories, there are even more distinct funds to choose from. For example, “sector funds” allow you to invest in a specific industry, like clean energy, while “growth funds” allow you to focus on companies with capital appreciation.
Professional Management: The primary advantage of funds is the professional management of your money. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is a relatively inexpensive way for a small investor to get a full-time manager to make and monitor the investment portfolio.
Investment Diversification: By owning “shares”(known as “units”) in a mutual fund instead of owning individual stocks or bonds, your risk is spread out. The idea behind diversification is to invest in a number of assets so that a loss in any particular investment is minimized by gains in others. In other words, the more stocks and bonds you own, the less any one of them can hurt you. Large mutual funds typically own hundreds of different stocks in many different industries. It wouldn’t be possible for a small investor to build this kind of portfolio with a small amount of money.
Economies of Scale: Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are lower than you as an individual would pay.
Liquidity: Just like an individual stock, a mutual fund allows you to sell the units at any time.
Simplicity: Buying a mutual fund is easy! The minimum investment is also very small; as little as Rs 500 can be invested on a monthly basis.
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