Imagine going to a new fast food joint for lunch. The food is new, the flavours are new, something you have never had before; but the reviews about the place have been so great that you want to try it out for yourself. Now when it’s time to order, you get confused because you are not sure as to which flavours complement each other well. Thankfully, that is when your clueless gaze pauses on the combo offers section. You inform the waiter of your taste preference and place an order. Extremely happy that you were economical with your budget by going for a combo instead of ordering expensive separate dishes, you enjoy the rest of the evening basking in the novelty of a new find!
Replace a few words in the above example with some technical terms, and you have yourself a Mutual Fund transaction. Never thought it was that easy? Well, it is. The word Mutual implies a group of people coming together, and Funds implies money. Therefore, Mutual funds suggest a group of people putting their money together to buy stocks or bonds, or in some cases, a combination of both. This fund is managed by professional Fund Managers who manage this pool of money and build a portfolio in line with the investment objectives (short-term or long-term) of the scheme. A mutual fund company collects money from several investors and invests it in different options (like the combo offer) for instance stocks, bonds etc. Since this company is run by a group of professionals, they understand the market and bring their expertise to the table. Ordinarily, it would take a long time for someone to understand the functioning of the markets or the reasons for its highs and lows. This is where the professionals of the MF step up and provide strategic and efficient plans of investing to those who wish to get better returns on their savings. These investments are spread across various stocks and sectors in order to balance out the failure of one stock with the success of others. This invested amount generates returns on the pooled investments and these returns are then passed back to the investors.
There are many types of MF schemes that one can invest in depending upon the personal goals of the investor. These schemes are based on maturity period, investment objectives, tax savings, specific sector, etc. Since the returns in MF are dependent on market conditions, the return on investment, despite being consistent, may not be as precise as a Fixed Deposit in a bank. But the upside to MF is that in a positive market, the returns can be greater than the estimated amount. Thus, there are several advantages of Mutual Funds namely- Easy liquidity, Diversification, Professional Management, Flexibility (mutual funds is for everyone), Low Transaction Cost, Transparency, Regulation and long term tax benefits.
Despite the fund being managed by professionals, since the markets depend on the economy, Mutual Funds are not risk-free investments. But there are certain risks like lack of Control, which an investor can be exposed to when the decision making ability lie in someone else’s hands (MF). The other common risk that can affect the portfolio of an investor is that of Large Diversification. Large Diversification could limit the upside potential in a scheme, as opposed to investing in just one blue-chip stock. Other risks include change in government policies, economic alterations etc.
Thus, mutual funds are subject to market risks; so when they say ‘read all scheme documents carefully before investing’, they mean it. They are only looking out for you!