What are mutual funds ; is it a better option than stock market?

When we got our salary we  use to save a small amount of salary for our future goals most of the people use to save in  their savings account which is not a good decision  because we got around 3-4 % interest only by doing that which is less than  inflation rate in India. So our money lose its value in  the savings  account. Many people want to invest their money but  don't  have enough time to invest in real estate or analyse a stock. Some people use to invest their money in gold which is a better option. But you know there is another way of investment by which you can generate even upto 25%. Yes that is mutual funds. Now the question is what are mutual funds? So in this article we are going to discuss everything about mutual funds and how does it work?

What are mutual funds?

A mutual fund is professionally managed investment funds which collects money from many investors and  invest that collected money into the gold, equity, or debt.

You may have listen the line "Mutual funds investments are subject to market risk. Please read the offer  document carefully before investing" . So mutual funds are really risky is there are any chances of capital loss? Lets discuss.

Mutual funds collects money from investors and use to invest that money into the gold, debt or equity in return of some fees which is called expense ratio. There are many types of mutual funds scheme like debt funds, large cap  funds, small cap funds, midcap funds, multicap funds, index funds, gold funds. You can simply choose the fund according to your needs and risk. When you invest an amount in mutual funds you  allocate a unit in that fund and you can redeem it anytime you want. But some schemes have time limitations like you cannot withdraw your investment before a specific time if you want to redeem you have to bear some charges. 

Some keypoints of mutual funds;

1. NAV (Net Asset Value)

The NAV is the market value of the assets minus its expenses and liabilities. NAV is used to  denote the performance of a mutual fund company. NAV is calculated at the end of each trading day based on the closing market prices. The formula of calculating NAV is 

NAV  = (Assets - liabilities) / Number of outstanding share

3. Asset under management (AUM)

Asset under management is the total investment value which asset management  of a mutual fund house manage on the behalf of investors or  clients.

4. Expense ratio

The expense ratio of a asset fund is the total percentage of total assets which is used for management, advertising and all other expenses. The expense ratio of most of the asset management companies varies from 1-2% unless it is an index fund. 

How does a mutual fund works?

Whenever we listen about mutual funds this question is always comes to our mind that how mutual fund company works?

Nowadays not everyone has the time to analyse the stock so some hires the financial advisors and some goes to mutual fund companies. You don't have to analyse a stock that's why every asset management company have a team of experts and a fund manager. That experts keep their eye on market that what is going on in the market and where is the good opportunity to generate good returns. They simply collect the funds from investors make a pool  of money and then make a portfolio of stocks. They have fixed the percentage for every particular stock that this specific percentage will go to this stock  and this percentage will go to this stock. 

Types of Mutual funds

1. Debt funds

This fund involves in the range of debt instruments to  reduce risks and generate returns. These mutual fund schemes are relatively safe and low risk funds from the equity mutual funds. As these mutual funds cannot generate much returns as equity funds so you can choose these funds to diversify your mutual fund portfolio.

2. Hybrid funds

These mutual funds use to invest in both equity as well as debt in different proportions. These  mutual funds are considered as moderate risk funds. Yeah these funds also cannot give you much returns as equity funds. but if you want to diversify your portfolio and invest into both equity and debt you can go with hybrid funds you don't need to go with a debt fund and a equity fund.

3. Equity funds

These mutual funds schemes are focused on stock market only. Yeah there are many types of funds in equity funds too like large cap fund, small cap fund, midcap fund, multicap fund. you can go  with the one according to the risk and return you want to generate. Usually small caps funds have high risk than other funds because the risk is very  high in the small cap funds because of undeveloped companies but on the other hand they have opportunities too to generate multibegger returns whereas in large cap funds invest in large cap companies which are already developed so risk is very low in those funds. 

And there is another type of mutual fund which is index fund. What index funds do is they just invest the funds in the indexes like nifty or sensex. because they only follow the indexes the expense ratio of these funds are too less. Even the big bull Warren Buffet has suggested to the beginners that if you don't know to read the balance sheets and also don't want to take risks you can simply go with the index mutual funds because  the economy of a country never goes down in long term you can simply make profits by investing with the growing economy of your country. 

Classification of mutual funds according to the sector;

The are some mutual funds companies also present in the market which are investing in the specific sector like banking  sector, finance sector, IT sector, FMCG sector etc. These mutual fund house focused at the specific sector if you want to invest in particular sector you can go with the these mutual fund houses.

Merits of investing in mutual funds

1. If you want to invest in those stocks which are higher in prices like MRF but you don't have enough money to buy even a single a stock you can invest in the mutual fund which has MRF in their portfolio because they collect funds from investors and invest the funds in different stocks.

2. You can diversify your portfolio, if you will buy stocks directly from stock market you find it very difficult to diversify your portfolio as buying different companies stock requires too much funds. But if you invest even 5000 RS. in a mutual fund scheme you can invest in many companies.

3. You don't need to analyse stocks by yourself as there is a team of experts in every asset management company and a well experienced fund manager who will manage your funds.

4. You can invest in gold and bonds also, yeah rather than equity there are many mutual fund schemes which use to invest in gold, debt and bonds also which you can use to diversify your portfolio.

5. Liquidity, It is very convenient to invest and redeem in mutual fund houses atleast from stock market. There are some liquid fund also which gives you a constant 7-8% returns. You can use those schemes for short term goals and you can redeem it whenever you need.

6. If you don't want to keep your eye regularly in market you  can make SIP (Systematic Investment Plan). so that an amount of your salary  automatically be invested at a fix  date. 

Demerits of Mutual funds

1. Expense ratio, Most of the big mutual fund houses have high expense ratio which can effect a lot in long term even a 2% of expense ratio can effect your wealth by big difference so always try to find the mutual fund scheme which has low expense ratio.

2. Focused, If a asset management company is focused at large caps only they cannot invest in midcap and small cap companies doesn't matter how big the opportunities in those companies.

3. Most of the mutual fund companies want to keep their reputation secure so most of  the time they don't take those risks which can generate a huge returns.

4. Lock-in periods, Most of the mutual fund houses have a lock-in periods due to which you can not withdraw your investment before specific time period. Yeah you can withdraw it but you have to bear some extra charges.

5. When market crashes all the investors use to withdraw their funds from the mutual funds and they have to sell the stock at the lower prices to give the funds of investors back. Yeah they want to buy the stocks at that time because the market is available at very lower prices but they can't do anything as the investors continuously withdraw their money.

Click here to get a free ebook on the basics of mutual funds.

How it is better option for those who don't have skills to analyse stocks?

Many people want to invest in stock market want to make profit by investing in their own country economy. But they don't have enough skills to analyse the stocks and don't know to  read the balance sheets. So, They can start with the mutual funds. In a little expense ratio you can hire a team of experts who will manage your funds and invest your money in the best stocks. You don't need to start with the big amount if you want to learn you can start with the small amount you can invest even 500rs in mutual funds. I have remember when I had made my first investment in mutual fund, I invested 500rs. in reliance nippon large cap direct fund. If you are reading this article and already made you first investment in mutual fund please comment down the name of the scheme. I will be delightful to know your first investment.

On the other hand many people find it difficult to invest in stocks while doing job. Because it requires too much time to analyse a stock and I know if you are doing a private job then you must be in office when the market opens so its quite difficult to buy and sell in the market too at the office time. So mutual fund can be the good alternative of stock market. You don't have to keep your eye on your portfolio and you don't need to analyse the stock. The mutual fund management will do all the things in the return of some expense ratio. And if you don't  have enough time to do these analysis you should not mind about the expense ratio. If you invest in good mutual fund you can earn upto even 22-25 % in long term. 

If you want to learn more about the mutual funds you can read this book its quite good I have read it personally. And also Someone said that the investment in knowledge can give you the best returns.

Conclusion

Yeah mutual fund is risky but if you are a long term investor and eye for long term goal. The probability of loosing the capital after 5 years of investment is almost zero. I am not saying that mutual fund is better than stock market or stock market is better than mutual funds. Simply if you want to minimize your risk or don't  have enough time to analyse the stocks you can go with mutual funds.

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