Definition of Mutual Fund
A mutual fund is a kind of investment that uses money from investors to invests in stocks, bonds, or other types of investments. This is considered the safest investment because investors invest money depends on market conditions and the calls taken by the fund manager.
Though risks remain at every investment, mutual funds are very well protected by regulation of the various competent authority of the Government. Mutual funds are professionally managed by financial experts and the investment is created by contributions from different investors who believe that the objective of the fund will earn them a profit.
Advantages of Mutual Fund
There are many advantages of investing in mutual funds. Some of them are as follows:
Mutual funds offer investors the opportunity to earn an income or build their wealth through the professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed.
Investing in the securities markets will require the investor to open and manage multiple accounts and relationships such as broking account, Demat accounts, and others. Mutual fund investment simplifies the process of investing and holding securities.
Affordable Portfolio Diversification:
Investing in the units of a scheme provides investors the exposure to a range of securities held in the investment portfolio of the scheme in proportion to their holding in the scheme. Thus, even a small investment of Rs. 500 in a mutual fund scheme can give investors proportionate ownership in a diversified investment portfolio.
Economies of Scale:
Accumulating large sums of money from investors makes it possible for the mutual fund to engage professional managers for managing invested funds. Individual investors with small amounts cannot afford to engage in such professional management.
Investors in financial markets are stuck with security for which they can’t find a buyer-, and they cannot realize their invested funds if they needed and they may suffer loss. But in the case of mutual funds, there are no such restrictions. Investment and redeem can do anytime as per the needs.
Mutual funds are not liable to pay tax on the income they earn. If the same income were to be earned by the investor directly, then tax may have to be paid in the same financial year.
Mutual funds offer options, whereby the investor can let the money grow in the scheme for several years. By selecting such options, it is possible for the investor to defer the tax liability. This helps investors to legally build their wealth faster than would have been the case if they were to pay tax on the income each year.
Specific schemes of mutual funds (Equity Linked Savings Schemes) give investors the benefit of deduction of the amount subscribed (up to Rs. 150,000 in a financial year), from their income that is liable to tax. This reduces their taxable income, and therefore the tax liability.
As dividends and other interest income sources are declared for the fund, they can be used to purchase additional shares in the mutual fund, therefore helping your investment grow.
Convenience and Fair Pricing:
Mutual funds are easy to buy and easy to understand. They typically have low minimum investments and they are traded only once per day at the closing net asset value (NAV).
Disadvantages of Mutual Fund
Besides advantages, mutual funds also have some disadvantages to being an investor in mutual funds.
High Expense Ratios and Sales Charges:
Mutual funds are subjected to high expenses ratios and sales charges. If the investors relax about these charges, it can get out of hand. If the expenses ratio exceeds 1.50%, they can be considered as higher costs and the investors have the reasons to be concerned.
Window dressing may happen if the manager is abusing the power. Unnecessary trading, excessive replacement, and selling the losers prior to quarter-end to fix the books.
Poor Trade Execution:
If you place your mutual fund trade anytime before the cut-off time for same-day Net Asset Value Per Share (NAVPS), you’ll receive the same closing price NAVPS for your buy or sell on the mutual fund.
Difference between Mutual Fund (MF) and Initial Public Offering (IPO)
The difference between MF and IPO are stated as follows:
|1.00||To launch a new mutual fund a new fund offering (NFO) is used by an Asset Management Company (AMC).||To raise capital by issuing new shares to the public an IPO is used by a public limited company.|
|2.00||The total fund is split and invested in a basket of assets.||The entire proceeds go to the company.|
|3.00||Shares are issued at the face value||Shares are allotted at the price arrived at through the book-building process.|
|4.00||The NAV is linked to the market price.||The post-issue price is linked to the demand-supply forces of underlying assets.|
|5.00||The NAVPS scheme is lower than the par value i.e. Subscription price.||The listing price may differ from the cut-off (subscription) price.|