WHAT ARE MUTUAL FUNDS?
A mutual fund is an investment vehicle that constitutes a pool of money collected from various investors in order to invest in securities such as stocks, bonds, money market instruments, and other assets. This helps in increasing the buying power of investors and eventually leading to diversified portfolios. Investors are able to buy a number of securities at a much lower price than investing in individual securities.
Small and individual investors gain access to professionally managed portfolios of equities, bonds and other securities through Mutual funds. The average mutual fund holds numerous of different securities, meaning mutual fund shareholders gain diversification at a very low price. Each shareholder, hence, acquires proportionally in the gains or losses of the fund. Mutual funds invest in a wide amount of securities, and performance is usually evaluated asthe change in the total market cap of the fund, obtained by aggregating performance of the underlying investments.
Mutual funds are registered with SEBI (Securities and Exchange Board of India), which monitors the security markets before pooling of funds from investors. Investors can simply buy and sell stocks or bonds online while investing in mutual funds.
The first advantage of investing in mutual funds is Diversification, that is, combination or mixing of investments and assets in the portfolio in order to reduce the risk factor. A diversified portfolio holds securities with different capitalizations and industries along with bonds that vary in maturities and issuers. A diversified portfolio can be achieved by investing in mutual funds at a much cheaper and speedy rate than investing in individual securities.
Reinvestment of Income.
Mutual funds usually permit to reinvest dividends and interest in additional fund shares. As a result, investors can expand their portfolio without having to pay regular transaction fees while buying additional mutual funds.
Investing in mutual funds is convenient since they can be bought and sold with ease on the stock exchanges which makes them an easier option for investment as well as liquid investments. Moreover, mutual funds become a viable choice for investors pertaining to specific assets such as foreign equities and exotic commodities.
Mutual funds are an ideal investment choice for individual investors. Since mutual funds are highly liquid, easily accessible, easy to understand, provide diversification, all these benefits make mutual funds feasible or individual investors who are not willing to actively manage their money and do not hold a huge amount of money for investment purpose.
As there are numerous investors involved in mutual funds investments, hence investors are frequently investing and withdrawing the money from the funds. Funds are required to maintain a large part of their portfolios in cash in order to keep up with the withdrawals. However, maintain cash leads to liquidity but on the downside, idle cash does not provide benefits.
While investing in mutual funds, investors do not have the option to evaluate P/E ratios, sales growth, earning per share and other ratios required to evaluate funds. Hence, it makes the researching process and comparisons for mutual funds complicated.
Though diversification is one advantage of investing in mutual funds, over-diversification may prove to be a failure. An investor while diversifying is a portfolio, manages to hold more and more securities, while in that case risk can be reduced but gain from single security will not affect the portfolio. Said in other words, however, risk can be reduced with diversification but with over-diversification so can the gains. Over-diversification, hence, can slip you off from your main financial objectives.
Fees and Expenses.
Sales charges can be charged on the purchases of some mutual funds, called load, which is the cost to acquire the fund. Additionally, annual expenses are charged with all the mutual funds. Annual expenses are termed as expense ratio which is a percentage that is paid annually as a part of their account value. Moreover, if investors seek professional management and they have to spend a cost for their expertise as well.