What is Mutual Fund?
CONCEPT AND ROLE OF A MUTUAL FUND
line with the common investment objectives agreed upon, between the mutual fund and the investors.Through mutual funds, an investor can get access to equities, bonds, money market instruments and/orother securities and they also avail of the professional fund management services offered by an asset management company.
Role of Mutual Funds
Assist investors in earning income or building wealth
Mobilization of savings
Facilitating the infusion of capital in the economy
Market stabilizer
Different schemes according to investment objectives
Various investors have different investment preferences and needs. In order to accommodate these preferences, mutual fundsmobilize different pools of money. Each such pool of money is called a mutual fund scheme. Every scheme has a pre-announced investment objective. Investors invest in a mutual fund scheme whose investment objective their own needs and preference.
Investment Policy of Mutual Fund
Mutual fund schemes announce their investment objective and seek investments from the investor. Thus, an investor in a scheme is issued units of the scheme. The scheme earns interest income or dividend income on the investments it holds. Further, when it purchases and sells investments, it earns capital gains or incurs capital losses. A mutual fund scheme with an objective of providing liquidity would invest in money market instruments or in debt papers of very short-term maturity. At the same time, a mutual fund scheme that aims to generate capital appreciation over long periods, would invest in equity shares. This would refect in the scheme’s asset allocation, which would be disclosed in the Scheme Information Document (SID).
Important Concepts in Mutual Funds
Units: The investment that an investor makes in a scheme is translated into a certain number of ‘Units’ in the scheme. Thus, an
investor in a scheme is issued units of the scheme.
Face Value: Typically, every unit has a face value of Rs.10. The face value is relevant from an accounting perspective.
Unit Capital: The number of units issued by a scheme multiplied by its face value (Rs.10) is the capital of the scheme–its Unit
Capital.
Recurring Expenses: The fees or commissions paid to various mutual fund constituents come out of the expenses charged to the
mutual fund scheme. These are known as recurring expenses. These expenses are charged as a percentage to the scheme’s assets
under management (AUM). The scheme expenses are deducted while calculating the NAV.
Net Asset Value: The true worth of a unit of the mutual fund scheme is otherwise called Net Asset Value (NAV) of the scheme.
When the investment activity is pro_table, the true worth of a unit increases. When there are losses, the true worth of a unit
decreases.
Assets under Management: The sum of all investments made by investors’ in the mutual fund scheme is the entire mutual fund
scheme’s size, which is also known as the scheme’s Assets under Management (AUM).
Mark to Market: The process of valuing each security in the investment portfolio of the scheme at its current market value is called
Mark to Market (MTM).
Advantages of Mutual Funds for Investors
Professional Management
Mutual funds o_er investors the opportunity to earn an income or build their wealth through professional management of theirinvestible funds. Investing in the securities markets will require the investor to get into a lot of formalities. Mutual fundinvestment simpli_es the process of investing and holding securities.Mutual fund is a vehicle to mobilize money from investors, to invest in different markets and securities, inline with the Mutual Fund
Why Investments?
There are often common situations we see regularly in our own life, or the lives of people around us. Though, there is no explicitmention of money in these situations, we intuitively know that money would be involved in each of these situations, whether it is for higher education, or to buy a house, or for a fund that helps for managing expenses post retirement. In the investment world, the requirements of these four are known as financial objectives. When we assign amounts and timelines to these objectives, we convert these into financial goals. There are numerous examples of such financial goals. Goal setting is a very important exercise, while planning for investments.
As seen above, all the _nancial goals are about the need of money that cannot be fulfilled through the in at that time. While theexpenses for the goal may be high or low, the income may be less than the amount required to fund the goal. This is where moneyneeds to be withdrawn from the investments – in other words, this is why one needs to invest the money.
Short term needs versus Long Term Goals:
Various goals have various timelines. And thus they are needed to be planned accordingly. Let’s look at the retirement goal for this. This goal can be broken into two parts: accumulating a sum for retirement, and then taking income out of the corpus thusaccumulated. Wisdom suggests that if one plans well for those important and not urgent tasks (and goals), life changes for the better.
In order to achieve this, it is important to classify the financial goals – those events in life in terms of timeline and importance inone’s life.
Savings or Investments?
The word “saving” originates from the same root as “safe”. The safety of money is of critical importance here. Whereas, when oneinvests money, the primary objective typically is to earn projects. The important point to note here is that there is a trade-o_ betweenrisk and return. The other deference is evident from the dictionary dentition of “saving”– reduction in the amount of money used.
This dentition refers to reducing consumption so that some money is saved. It is this saved money that can be invested. In otherwords, saving and investing are not to be considered as two completely different things, but two steps of the same process – in orderto invest money, one need to save interest. Thus, saving precedes investing.
