MUTUAL FUNDS – EVERYTHING YOU NEED TO KNOW

MUTUAL FUNDS – EVERYTHING YOU NEED TO KNOW

In order to have some efficiency in the stock market, the tendency now is to form a group of people and carry out the activity within the framework of a particular regime of mutual funds. Each person must contribute to become a member of the group and the profits made are shared by the members of the association. The government has changed certain mechanisms to ensure that the mutual funds set up in the various segments function properly and that their actions are not to the detriment of savers. In some developed countries, hundreds of mutual funds have been created with specific objectives and aimed at serving specific types of savers.

A mutual fund is a professionally managed form of collective investment that pools money from many investors and invests it in stocks, bonds, short-term money market instruments and/or other securities . Nowadays, bank rates have come down and are generally lower than the rate of inflation. Therefore, keeping large amounts of money in the bank is not a wise option because in real terms the value of money decreases over a period of time. One of the options is to invest the money in the stock market. But an ordinary investor is not knowledgeable and skilled enough to understand the intricacies of the stock market. This is where mutual funds come to the rescue.

A mutual fund is a group of investors operating through a fund manager to buy a diversified portfolio of stocks or bonds. Mutual funds are very profitable and very easy to invest. By pooling money into a mutual fund, investors can buy stocks or bonds with much lower transaction costs than if they were trying to do it on their own. Also, there is no need to figure out which stocks or bonds to buy.

Advantages of Mutual Funds

There are many reasons why investors choose to invest in mutual funds with such frequency. Let’s break down the details of a few.

Advanced portfolio management

When you buy a mutual fund, you pay a management fee as part of your expense ratio, which is used to hire a professional portfolio manager who buys and sells stocks, bonds, etc.1 this is a relatively small price to pay to turn professional. assistance in managing an investment portfolio.

Reinvestment of dividends

Because dividends and other sources of interest income are declared for the fund, they can be used to purchase additional shares of the mutual fund, helping your investment grow.

Risk Reduction (Security)

Portfolio risk reduction is achieved through the use of diversification, as most mutual funds will invest in 50 to 200 different securities, depending on the objective. Many index mutual funds have 1,000 or more individual positions.

Convenience and fair price

Mutual funds are easy to buy and easy to understand. They generally have low minimum investments and they only trade once a day at the closing net asset value (NAV)1. This eliminates price fluctuations throughout the day and the various arbitrage opportunities practiced by day traders.

Disadvantages of Mutual Funds

  • High cost: There are no free lunches in this world. Similarly, mutual funds also incur costs in the form of expense ratios. The expense ratio covers fund management fees, marketing and sales expenses, etc.

A high expense ratio directly affects your portfolio returns. Investors who prefer a lower expense ratio can invest in “index funds”.

  • Abuse of management authority: Some fund managers may shuffle the portfolio unnecessarily. Portfolio churning is a constant buying and selling of stocks.

High portfolio turnover increases taxes and other costs. This reduces portfolio returns. Constant churning can also cause your fund manager to make poor investment decisions, which can lead to substantial losses.

  • Communication period: ELSS and FMP come with fixed comk-in periods. They are very illiquid and cannot be used in an emergency. Ideally, mutual fund beginners should avoid FMPs.

ELSS funds are a great tax-saving option. But only investors who can stay invested for at least 3 years should invest in ELSS funds.

  • Exit charging: The exit charge is a penalty charged by the fund house when redeeming before a specific period. Different fund types carry different exit charge periods:
    • Liquid funds have an exit load period of 7 days.
    • Debt funds have an exit load period of 30 days to 540 days (credit risk debt funds)
    • Equity funds have a 365-day exit charge period.

Investors should match their financial goals with the fund’s exit charge period. For example: if an investor wishes to invest for 10 days, he must invest in liquid funds and not in debt funds.

  • Over-diversification: Diversification is a double-edged sword. Although it reduces risk, it also dilutes the profits made by investors. Sometimes fund managers invest in too many asset classes. This is called over-diversification. To avoid this, investors should do goal-based financial planning before investing.

Dolores W. Simon