Mutual Fund

What are Mutual Funds?

Ever had a slice pizza because you were not hungry enough for a whole pizza? Investing in mutual funds is a bit like that. If you do not have the risk appetite for equities as an asset class, and are not confident of buying individual stocks in your portfolio, you can opt for mutual funds.

A mutual fund is a market instrument that pools in money from several investors and invests their funds in stocks, bonds and money market instruments.

A company managing several mutual fund schemes is called an Asset Management Company (AMC) and is closely watched and regulated by the Securities and Exchange Board of India (Sebi) and they must all comply with a strict set of norms that have been designed to protect investors.

While choosing a mutual fund scheme, you need check out the prospectus of the fund which gives you information about

  • The history of the fund
  • The fund manager who is responsible for managing the fund
  • The objective of the fund
  • Its performance record

Here are some Objectives of Funds

Objective of fund What instrument it will invest in
Equity fund Stocks of several companies
Debt or Income fund In fixed income securities
Gilt or Money Market fund Largely in government securities in short term money market instruments
Balanced fund (to achieve balance between risk and returns) Partly in equities and partly in debt instruments

Benefits of investing in mutual funds

  • Professional money managers invest on your behalf
  • Gives you an opportunity to diversify assets
  • The benefit of liquidity as you can sell your mutual fund units within a time frame of three days.
  • The minimum amount of investment is as low as Rs 500 in some schemes
  • You can easily track their performance by keeping a watch on the NAV or net asset value of the fund (calculated by AMCs at the end of each business day)

Things to avoid while investing in mutual funds

  • Resist the temptation to book profits every now and then. Trying to “time” the market will prevent you from reaping the benefits of this investment tool.
  • Over diversification of your portfolio, i.e having too many funds of the same kind does not benefit your portfolio. It becomes cumbersome to track the portfolio and also affects its long term performance.

Let us understand why you need to invest in mutual funds with the help of some examples

Let’s say your current monthly expenses are Rs 30,000 per month currently. To maintain the same standard of living you would require Rs 80,000 only 20 years down to line.

Impact of inflation on monthly expenses

Today Rs 30,000
5 years Rs 38,288
15 years Rs 62,368
20 years Rs 79,599

Equities outperform over other asset classes over the long term

Cumulative annualized returns 1980-2010

WPI Inflation 6.75%
Bank FDs 8.96%
Real Growth 2.08%
BSE Sensex 16.75%
Real Growth 9.37%

Basis of calculation

Individualised real growth for bank FDS & BSE Sensex calculated for each year. Post this CAGR calculated for the same. Hence the real growth of FDs & Sensex is not equal to the growth minus WPI Inflation

Saving a small sum of money in equity MFs regularly can make your money grow significantly thanks to the power of compounding

  BSE SENSEX Scenario A BSE SENSEX Scenario B
Number of years 15 20
Monthly investment Rs 5000 Rs 5000
Total Investment Rs 9 lakh Rs 12 lakh
Annualised returns 18% 18%
Total corpus Rs 45.96 lakhs Rs 1.17 crore
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