MF Series 1 : What is a Mutual Fund?
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MF Series 1 : What is a Mutual Fund?

A mutual fund is a corpus collected and maintained by Asset Management companies which will be invested in buying shares of companies or debt instruments on your behalf. The income thus generated will be shared amongst the investors.

How does a mutual fund work?

AMC announces the start of a fund by advertising through several different sources. Investors find this and try to invest in this fund. Investors put in their money. When the fund date of the New Fund Offer (NFO) ends the fund managers will be knowing the amount of money they have collected. From all the investors like you, the total amount would be in the range of crores depending upon the credibility of the AMC. Let us say the amount collected is 2000 crores. This amount is then invested in buying several different shares based on the risk profile of the fund and the equity to debt ratio. Most of this is transparent and is public information.

How do the AMC’s make money?

They do so by deducting the charges from the amount you invested in. You have invested 5000/- Now there will be a entry load. It ranges from 1%-2%. This will be deducted from 5000/- and the rest of the amount is divided by the prevailing NAV and you get the number of units. This units are publicly traded and will go up or down depending upon the market. The current NAV of you fund can be found from financial dailies. If you would like to withdraw your funds then you will be charged an exit  load (usually 1%). This money is used to pay for the fund managers and their staff and also this will be their profit margin.

Who can be an Asset Management Company (AMC)?

Asset Management companies maintain a large corpus of funds (upto 60,000 crores) has to pass through the SEBI guidelines. You need a net worth of atleast  10 crores at all times to start an AMC and there are some other guidelines to start an AMC. Unit Trust of India is the oldest AMC and the Reliance (ADAG group) is the biggest AMC in terms of amount of money being managed.

Why should I invest in Mutual Fund?

There are several advantages if you invest in a mutual fund. The first and foremost being the professional management. You have a dedicated team of financial analysts punching through numbers to gain the maximum advantage from the market. This is their day job. That is the reason why you pay for them.

Other advantage is, let us say you want to by Infosys shares but you only have 5000/- to invest. You would get a maximum of 3 or 4 shares (depends on when you are reading this). But, you truly believe in the growth of that company and really wanted to invest. The go ahead and invest in that. Now, you want to invest in one more sector and don’t have the money to do it. You really do not want to sell your Infy shares. You are stuck. This is where mutual funds fill the gap. You are indirectly holding several different shares of companies in various sectors. You diversify your investment. That is the unique selling point for a mutual fund.

Other advantages include but not limited to :

  1. Low cost
  2. Liquidity
  3. Transparency
  4. Tax benefits.
  5. Diversification (explained above)
  6. Professional management (explained above)

How can I invest?

Investing in a mutual fund is a breeze if you have already selected a fund. All you need is a demat account. Most of the online trading accounts sell mutual funds online. It would be easier to track too. ICICI Direct is my personal favorite. Other banks are offering this too. Once you login to ICICI Direct you can hit the Mutual Fund section buy the fund you want for the amount you want and you should be good to go. You will be allotted a few units based on the Net Asset Value (NAV) prevailing on the previous days close.

Other methods are :

  1. Buying directly from the AMC
  2. Buying it from the bank. Banks sell a fixed number of products and their breadth is limited. The gain which they obtain by selling the product to you is far greater than the gain you obtain from buying the product. So do your research.
  3. Buying it from an independent financial advisor. These are professionals who try to sell you products from several different companies. But the problem is they hard sell the products which has maximum gains for them. This might not suit your financial objectives. So hear them out but do your research from the resources given below.

Where can I get more information?

While we are covering it in a series of articles, if you would like the information you can head to any of the following links to get more.

Value Research Online