Mutual Funds: A Wide Angle View
By Richard Cox
A mutual fund is a registered and regulated investment entity that pools money from a large number of investors and invests it in different securities like bonds, stocks, short-term money-market instruments, other securities or assets, or some combination of these investments. These different securities are called holdings which combine to form one mutual fund, called a portfolio.
Classifications of Mutual Funds
Broadly, mutual funds can be viewed as a form of indices trading and are classified on the basis of their structure and their investment objective. Based on their structure they are categorized as Open-End Funds and Closed-End Funds. Open End funds are those who do not limit the number of shares or units they can offer and can be bought and sold on demand. Thus, investors can enter and exit as per their own convenience.
Closed End Funds are those where only a specific number of units are sold with a fixed maturity. Thus new investors cannot enter, nor can existing investors exit till the scheme ends. On the basis of their investment objective, mutual funds are further classified into Growth Funds, Income Funds, Balanced Funds and Money Market Funds.
How Do Mutual Funds Work?
The valuation of a mutual fund is based on its Net Asset Value (NAV), which is calculated by dividing the market value of the fund’s assets (minus its liabilities) by its number of outstanding shares.
How does a mutual fund work? As explained in the opening paragraph, an investment company opens a mutual fund and designates a theme to it, e.g. Vanguard Prime Mutual Fund and invites shareholders to invest in it.
On a day-to-day basis, the fund manager reassesses the previous day’s market performance, compares their fund’s return with others, and analyses the indicators that are affecting the value of the fund. Based on these trends, the team will buy and sell stocks, bonds or other investments with the mutual fund’s money. Periodically, the owners of the mutual fund will gain from their investment by the dividends declared by Mutual Fund Schemes. In other scenarios, if the fund sells the securities that have increased in price, the owner of the fund makes a capital gain.
Periodically, the owners of the mutual fund will gain from their investment by the dividends declared by Mutual Fund Schemes. In other scenarios, if the fund sells the securities that have increased in price, the owner of the fund makes a capital gain.
Benefits of Investing in Mutual Funds
Mutual Funds are beneficial in three broad ways. First, they invest in multiple companies across a broad section of industries and sectors and thus reduce the volatility of returns through diversification. Second, prices of open-ended mutual funds are stated daily and hence provide the advantage of transparency to its investors. Third, all Mutual Funds are registered with national regulatory authorities and hence function under the stringent regulations intended to safeguard the interests of the investors.
In conclusion, Mutual Fund is a financial instrument that has different benefits along with a certain degree of risk. As with any other scheme, an investor has to use his discretion and his knowledge of the financial system to get better returns and a satisfaction of accomplishing a successful investment.
MUTUAL FUNDS – A WIDE ANGLE VIEW