What are mutual funds?
Mutual funds are the diversification of investment.
In simple language, when you invest through mutual funds, first of all, you can start with any amount for investment in mutual funds, your money will be invested by a fund manager appointed by an asset management company who invests your money in stocks of several companies. As your money is invested in several companies, even if you face losses in one or two companies, it will be recovered from another company’s stocks. You will definitely face gains as well as losses but in long run, it is always profit. Once a wise investor Said that one should not invest all his money in one place, and this is the reason why Mutual funds are more profitable as compared to other investments because they are already diversified.
Let’s understand the principle of Mutual Funds using two scenarios.
- As we all know the percentage returns in Bank FDs are low (5–6 %). So to generate higher returns you decide to invest in a good company. Say, Maruti Suzuki India Ltd. Let’s say you have 2000 rs to invest. Now the stock price of a single share is around 8000 rs. What will you do. You can’t buy a quarter of a stock… right..??? or say you want to buy a corporate bond issued by Reliance company with a guaranteed return (yield) of 8%, but the minimum investment amount is 10000 rs. .. then how do you invest in this ..???. Now you ask your closest 3–4 friends to pool 2000 each so that you can jointly buy a single maruti stock or the bond. This is nothing but a fund used to buy a single stock/bond. Now, the single stock will be owned by each of you and the profits will be shared mutually. This is one aspect of mutual fund.
- Now, you have invested in the stock, but you are not able to keep a track of investment because of your busy work schedule. You don’t know when to buy more of this stock, or when to sell this and buy any other. What do you do then..??. You, then, hire a professional expert to invest on behalf of you and your friends. This investment can be in any stock, bond, gold, silver etc. Investing the funds money, meeting the regulatory requirements, shifting the fund from one stock to another, or one asset class to another is this persons full time job. You are only concerned about the return you get. This is the second aspect of Mutual fund.
So, Mutual Fund is nothing but a Professionally managed huge sum of money.
Coming to the second part of the question -
Mutual funds get money either through monthly/quarterly investments or Lumpsum. MFs can use this money to invest in anything such as -
a. Shares of companies
b. Bonds issued by companies
c. Commodities (Gold, silver, or crude oil)
Most of the common Mutual Funds that we hear about invest in the first two instruments.
E.g.- Let’s take the example of
This fund currently has 96.37% of the total fund value invested in Indian stocks of which 75.83% is in large-cap stocks, 7.8% is in mid-cap stocks, 1.06% in small-cap stocks.
This is just one example of a Mutual fund that invests in equity. let’s take another example of a fund that primarily invests in bonds (debt instruments) say -
ICICI Prudential credit risk fund.
This fund has 94.03% investment in Debt of which 13.2% is in Government securities, 50.52% in funds invested in very low-risk securities…
The type of investment (portfolio) a Mutual fund holds depends on the “professional expert” who handles it (started it). Some invest in Large-cap companies, some in small-cap, some in debt. Some invest in only a certain sector (e.g. — SBI Technology fund).
You can check the allocation of any mutual fund by using any popular website like moneycontrol, value research online, crisil, Motilal Oswal, etc.
These investments, made by the fund, in these instruments, get appreciated because of the interest earned through bonds, or appreciation in the price of stocks, or because of the dividends given by stock. And so does your investment appreciates.
The performance of any mutual fund is gauged by something called “NAV” Every fund has a NAV, (Net Asset Value).
When you make a SIP of say 2000, you don’t actually buy the shares of companies, but by the shares/units of the Mutual Fund at a price called NAV. As the fund performs well, its NAV grows, and so does the value of your investment.
NAV = (assets — liabilities)/no of shares.