Mutual funds are right you must have heard this at some point, you either would've seen an ad on TV or heard it from someone. But you probably never understood that mutual funds are right, but which one is right for you? What are mutual funds and How do mutual funds work and in what places are mutual funds invested? And as an investor, what things about mutual funds should we keep in mind? And apart from this, a very important thing, that by investing in a mutual fund, what expenses do we have to give and how we can minimize those expenses. And in this article, we also tell you, how we can determine risks because every time you must've heard, that before investing you should see your risks, so we will discuss that as well in this article.
Why is a Mutual fund better?
Why mutual funds are right, every person who earns money like you and me after earning we think that we should invest somewhere. Take, for example, I think that I should invest in the stock market but I am a very common investor and I don't know which stock I should invest in and the biggest confusion in front of me even after I find a good stock, at what time do I have to enter the stock and at what time should I exit the stock.
And the whole day I'm busy with my work and cannot concentrate on the stock about at what time should I exit from stock and because of this, for an investor, mutual funds are a very good instrument for investment. Because mutual funds on our behalf, make investments in different financial instruments.
But the question is How? Let see this step by step firstly, small investors like you and I Who want to invest their money somewhere or others give their money to AMC's.
What is a mutual fund?
The regulation obliges mutual funds to offer investors a wide distribution of securities, mostly fixed-income securities. Distribution will be through intermediaries such as retail and even third-party distributors.
So, while the index constituents of a mutual fund can be the stocks of the corporates or listed companies, all of which have a history of increasing value, for retail investors, the idea is to put their money into those companies whose performance is better in the market than others, and outperform the other sectors that comprise the fund. For this, a good understanding of their business and investing strategies is paramount.
“In other words, do not go for the tiger, chase the cow”, said Ram Mohan, a veteran investor.
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What is AMC's in a mutual fund?
AMC's are Asset Management Companies like Axis, Kotak and many other companies apart from this are in India Who, pool money from investors like us in one place and after pooling the money, there is a very experienced and educated fund manager is the person, who invests our pooled money in different places.
So the first step is, the money of investors like us, gets pooled in an Asset Management Company. Now, the fund manager will invest the combined money in various financial instruments. The different places could be investing in debt, equity, government, and securities. Apart from this, there are a lot of instruments in which the money can be invested. In the process that the fund manager invests the money in different instruments.
What can those instruments be in mutual funds?
1. share market
A lot of fund managers invest in the share market depending on the objective of that particular mutual fund. If I tell you about the share market, then they invest in a company's share, with which they get some shares of the company.
2. Debt
What are the different types of equity funds in a mutual fund?
There are some subcategories under equity in which mutual funds make investments. If I talk about equity, there are mainly three subcategories,
1. large-cap companies
Large-cap companies are the very big companies like Reliance t.here is very little risk of investing in these companies and the return is very normal
2. Mid-cap
In the same way, if I talk about mid-cap companies then these companies, are neither too big, nor too small there is a little more risk of investing in these companies and sometimes they give good returns as well.
3. Small-cap.
Apart from this, small-cap companies, who are very small companies and have the potential to become big companies in the coming time.
So, whenever you invest in any mutual fund, then they very clearly tell you where they are going to invest their money. Will they invest in large, medium, or small sectors? And many funds make their investments in all three categories which are called Multi cap mutual funds.
Financial Jargon examples in Mutual Fund
A big problem that investors like you and I face, is that many financial jargons which we hear while investing whose meaning we do not understand at all.
For example, when we go to invest in a mutual fund, on every website, we can see that, terms like AUM are written, Expense ratio, fund manager and apart from this, NAV. We do not really understand what it means.
Now, let understand step by step what each financial jargon means and how that impacts our investments. Let take the first financial jargon
1 Financial jargon is Asset Under Management (AUM)
Like I just told you how a mutual fund works. Firstly, many investors, pool their money with an asset management company now consider that a fund was going to start for which 100 investors pooled 100 Rupees each. So, what is the total amount? The total amount is 10,000 Rupees. So, this 10,000 rupees pooled, is known as AUM Asset Under Management. So, the money after being pooled, that an asset management company manages in that fund, is known as Asset under management.
So, why is AUM important in any investment we make in a mutual fund? Because whichever mutual fund's AUM is more, the liquidity there is good and if the liquidity is good, so whenever you invest money, and you want to remove that money, you will never have a problem.
2. Financial jargon is Net Asset Value (NAV)
Let see in very simple terms. Whenever you buy stocks, you buy them at a price. For example, you purchased a share whose price was ₹50 in the same way when you go to buy a unit of a mutual fund, then, the price of that mutual fund is called NAV. Now, consider that the total asset under management was ₹10,000 and after a year, it increases to became ₹20,000 because the fund manager invested the money in a good place. So, one person, who took ten units, when he bought it, the value was ₹10 now, its value will increase to become ₹20 so, as the NAV continues to increase, your return from one mutual fund starts to become better.
3. Financial Jargon is Expense Ratio
The third and very important financial jargon in mutual funds is known as the Expense ratio. Now, what is an expense ratio? As I told you above, that retail investors pool their money in an asset management company and that money is further invested by a fund manager. For a fund manager to invest the money he has to do a lot of research and the asset management companies have to undergo a lot of expenses to manage the different funds because they have to do research that, at that time, where should they invest so, where do all those people get all that money from? Therefore, for all investments, if you invest in a mutual fund you must provide the average cost.
Now, let's say that you have chosen to invest in ABC mutual fund, and when you went to the Groww website, you saw that that the expense ratio to invest in the mutual fund is 2.3%. Take for example that you invest ₹100 then in one year you have given an expense of ₹2.3 to the asset management company so, whenever you choose a mutual fund, then pay attention that in that category, what the expense ratio for the other mutual funds are and if you invest in a mutual fund whose expense ratio is too much then you will get fewer returns So, lesser the expense ratio, better the return.
4. Financial Jargon is an Exit load
The first thing you have to keep in mind is that whenever you make an investment, make it for the long run. Because you always get a good reward over time. And mutual fund also focuses on this topic and whenever you invest in any mutual fund then the mutual fund tells us that you have to make the investment for a certain amount of time at a minimum. But, if you find an emergency somewhere and you have to withdraw money there, then, therefore, you have to give a certain amount of the cost of that.
Take for example, that you invest in ABC mutual fund Its exit load was 1% and they say that their exit load will take up to 1 year if you make an investment today, and between now and a year later, you remove your money, then, on every ₹100, you have to give ₹1 to the asset management company. But, for example, if you made an investment today and you remove the money after three years then you don't have to give the exit load and every mutual fund has a different exit load.
5. Financial jargon is regular and direct mutual funds.
You must have heard the word in general and you probably don't understand this sometimes and don't think about it very well, you think it doesn't make much difference. First, let us understand the difference between regular and direct mutual funds. Regular investment is when you invest in a mutual fund through a broker or an agent in this, your expense ratio is slightly more as compared to direct mutual funds.
What happens in a direct mutual fund is that, whenever you make an investment then your investment takes place directly with the AMC there is no agent or broker in between. Now you must be thinking that between regular and direct investment there will be a 1% expense ratio difference at most so what difference can that 1% make.
Let understand this in figures, how much difference that 1% can make in long time investment. What a big advantage investing through direct mutual funds has if you make an investment of ₹20,000 for the next 20 years, every month in an asset that gives you only a 9% return. Then your money increases and comes out in excess of 1 crore 27 lakhs. Now, consider that this was a regular mutual fund and instead of that, you invested in a direct mutual fund Which takes an expense ratio that is 1% lesser than your return increases and changes to 10%.
So, your invested value which increased to 1 crore 27 lakhs will now increase to around 1 crore 43 lakhs. So you can see that return of 1% can have such a big effect on the invested value for investment in the long run.
What are the risks involved in mutual funds?
What are risks and how do they work and why while investing should we pay attention to risks. Now consider that you want to make an investment of ₹100 you will always think about how you can make that 100 into 105 or 110. But there are chances that 100 can go down to become 90 as well So, this is called a risk that there are chances of your money going down this is what we call risk. So, we should always avoid our risks, we should always try to minimize our risks and by minimizing our risks, we should try to get a good return.
Now, every person has their own personal risks and risk is dependent on many factors. For example, on your income, on your age and apart from this, for how long you want to invest. Now, consider that you are very young and you want to invest for a very long time. Because if you invest for a very long time then your risk gets neutralized. But you're quite old and you might need money at any time, then your capacity to take risks is very low. Then you should invest in such an instrument where the risk is very low.
Now, the benefit of investing in a mutual fund is that we get a lot of risky instruments to invest in. If you want to take a very high risk, then you can invest in such a mutual fund, that has very high risk but can also provide good returns. If there are some people who want to take a very little risk, or if they want to take a very negligible risk then there are some options, which on investing, there is very little risk, but the returns won't be that much either.
Conclusion
If you want a good return then you have to take high risks but vice versa isn't true by taking more risks, it is not guaranteed that you will get high returns. So, here I will give you a little advice first you should see your risk, to see how much it is, then you should see your mutual fund to see how much risk it has and when both your risks match, that becomes your best investment option.
