Mutual funds are an easy way of subverting this problem. The concept is quite simple. Investors pool their money together in a fund. This fund is then entirely invested by a professional. As a result, the level of risk each individual investor is subjected to, is significantly watered down.
Mutual funds are managed by professional fund managers. The advantage of dealing with a larger amount of money is that it can be invested in a variety of stocks, bonds and other securities. In other words, instead of choosing any one stock or one form of financial security, you can invest in a portion of an entire well-rounded portfolio.
The price of a mutual fund is called its Net Asset Value. It is obtained by calculating the total value of the portfolio. This is then divided by the number of units of the fund which are available for sale to individual investors. The Net Asset Value, is like the price of a share. It fluctuates frequently, to reflect changes in the market’s perception of the fund.
Mutual Funds: Origin
Mutual funds have been a part of financial markets since as early as the 18th century. Abraham van Ketwich formed the first investment fund in the Dutch Republic soon after the financial crisis of 1772. The aim of doing this was the same as it is today; it provided smaller individual investors the opportunity to diversify their investments.
Mutual funds as we know them today, were introduced in the United States towards the end of the 19th century. These were primarily closed funds in nature. They traded a fixed number of shares which was not subject to any change. The first open ended fund that was launched was the Massachusetts Investors Trust, which was established in 1924. In fact, this fund is in existence even today.
Since then, mutual funds have gained an immense amount of popularity. By the end of 2016, mutual funds across the world had a combined asset value of over $40 trillion. As expected, the largest mutual fund industry is housed in the United States. Here, almost 22% of all household assets are held in the form of mutual funds.
What makes Mutual Funds so attractive?
- Economies of Scale
This is the primary advantage of any mutual fund. What this means is, as the scale or size of the fund for investment grows, it brings with it certain benefits which are absent in small scale individual investments. A larger fund brings the possibility of a more diversified portfolio which brings down the exposure to risk for any individual investor.
- Professional Management
Mutual funds are managed by professional fund managers who bring with them a level of expertise that is lacking in amateur or small scale investors. This is paramount in the process of identifying the correct investment avenues and recognising financial opportunities before the rest of the market does.
The method of investment that is used by mutual funds is the ideal way. Any prudent investor knows that it is not wise to put all ones eggs in one basket. Spreading the investments out over different sectors and different financial instruments reduces the level of unsystematic risk i.e. the risk associated with any one particular avenue. However, for individual investors, the small scale of investment simply does not allow for the suitable amount of diversification. Mutual funds provide the perfect solution to this problem. Investors can simply avoid the conundrum of Compare Broker In India.
Mutual funds offer a degree of liquidity that is absent in most other forms of investment. Any investor can simply sell their units of the fund and cash out at any time in the stock market. Of course, whether the amount is more or less than the initial investment will depend on the duration of the investment and a few other factors.
Mutual Funds: The Ugly Truth
While mutual funds come with advantages galore, they are not all sunshine and rainbows. There are several disadvantages associated with mutual funds, as follows.
- Administrative Costs
While mutual funds offer the expertise of a professional fund manager, investors also have to bear the costs associated with such a manager. Investors do not have to compare brokerage charges of demat account. However, each investor is charged a certain percentage of their investment for administrative expenses i.e. the cost of maintaining the fund. This is an added expenditure that would have been absent in personal investments.
- Unpredictable Income
Individual investors have no control over the functioning of the mutual fund. This means, it is impossible to predict the amount of income that can be generated or when it can be expected to reach the investor. Personal investments are easier to track in terms of the amount of dividend payed or reinvested. With a mutual fund however, this is simply not possible.
- No opportunity to customise
Investors have no control over the investments made by the fund. They are, of course, notified and provided with all the required information in accordance with the regulations and standards. But individual investors have no option of adding their personal inputs and quirks into the investment mechanism. It is impersonal and impossible to customise.
To Sum Up
Mutual funds are the perfect method of investment for amateurs who are just starting off in the stock market. They are safer than investing in stocks on ones own and offer a level or professional expertise which is valuable in the stock market.
However, mutual funds too, are not without risk. Diversification can only go so far. That is why it is important to be prudent and informed while choosing which mutual fund to invest in. There are a variety of funds available in the stock market, in terms of the financial instruments invested in, the duration of the investment and the structure of the fund.
As an investor, you need to choose the fund whose investment principles align with your own as closely as possible. You have to take into account the investment goals, the risk appetite, the historical performance of the fund and compare demat account charges in India. Only then can the true benefits and advantages of mutual funds be utilised optimally.