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To begin with, a mutual fund is a professionally managed firm of collective investments that pools money from many investors and invests it in stocks, bonds, shares, etc. It pools the savings of a number of investors with common financial goals.
How does a mutual fund investment work ? Consider a group of investors who pool their money collectively with a fund manager, who in turn invests it in what he thinks are the best of securities, bonds, shares, debentures, and stocks. These securities, bonds, debentures, stocks, and shares in turn generate returns which are then passed back to the investors. One notices that this process is a whole circle and ends where it originally started.
The term ‘mutual fund’ was first coined in the year of 1963 but only picked up from the year 1987 when bigger players entered the industry and started pooling their resources. Research suggests that
mutual fund investments are one of the best ways to invest a person’s money and is also one of the most popular ways today.
There are different kinds of mutual funds in which one can invest.
Based on the structure, there are three kinds of mutual funds:
• Open-ended funds
• Close-ended funds
• Interval funds
Based on the investment objective, there are four kinds of mutual funds:
• Growth funds
• Income funds
• Balanced funds
• Money market funds
Other schemes include tax saving schemes, index funds, special schemes, and sector specific schemes.
The working of a mutual fund is done in two ways. Suppose the amount one wants to invest is Rs. 50,000/- in the lump sum or the one-time payment method, then the Rs. 50,000/- will be put in at one shot. In the Systematic Investment Plan (SIP), one invests money on a monthly basis. Thus, the Rs. 50,000/- can be invested over 10 months, making the per month investment Rs. 5,000/-
There can be several reasons to invest in a mutual fund. The first reason is for liquidity. Thus, if one decides to liquidate one’s shares in the fund, one can easily do so. By just letting one’s broker know that one wants to sell his/her shares, it can easily be done at the end of the trading day. Diversification is also one of the primary reasons to invest in a mutual fund. Instead of investing in one particular share, one can invest in several different ones and thus diversify one’s portfolio. As an individual, it is unlikely that one will be able to diversify one’s portfolio enough as the amount of capital needed will be too large. By investing in a mutual fund, one is taking advantage of the ability to pool one’s funds together with those of others.
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