MUTUAL FUND BASICS

Ok let’s try and make things a little simpler. Simply putting it a Mutual Fund (MF) is a corpus of money(funds) that is collected from a large number of people by a company (who manages the fund) and deploys this money in the market on behalf of these small investors. For e.g a MF will collect money from 6 lakh small investors to the tune of 600 cr and deploy this money to buy shares from the market on behalf of these 6 lakh people

Why Should I invest in a mutual fund?
For people who don’t have an experience in the stock markets its nice to start with mutual funds. For a starter since mutual funds are usually less risky and do not have the same kind of volatility that many stocks have... Secondly MF’s are professionally managed, so it is safe to assume that your money is in safe hands. So usually it is less risky to invest in them. As the old maxim goes higher the risk higher the returns. Conversely the returns also would not be the maximum

How do mutual funds work?
Mutual funds can be of many types. We are discussing equity mutual funds. These funds deploy the capital collected from the public into many stocks. There is usually a dictum that the mutual funds follow that not more than 5% or 10% of the corpus can be invested in a single stock. Within equity mutual funds, also there are many sectoral mutual funds, e.g. banking mutual funds, infrastructure mutual funds, power mutual funds etc that invest only in the companies in those particular sectors. Also there is the option of growth or dividend funds.

How do I choose a fund?
Its very important to choose a fund that has certain credentials attached to them. The most critical thing that needs to be checked is the performance of the fund over a period of time. If the fund has been consistently beating the markets rate of returns then it can be considered, provided it has the backing of a big house or a very reputed name.

What is the difference between growth and dividend funds?
A growth MF will deploy the profits earned through investment back in the MF corpus, so that the MF can buy more stocks, whereas a dividend MF would regularly disperse cash to the clients, hence the Net Asset Value would get adjusted accordingly

What is a SIP?
Sip stands for Systematic Investment Plans. Basically in SIP you buy certain fixed amount of mutual funds unit every month. SIP works well for long-term investors as one gets more number of mutual fund units when the markets are down in some months. For e.g. to make the calculation clear. Every month Ram allocates Rs 1000 to invest in banking mutual fund. Lets say in the month of Jan 08, the value of a single unit of banking mutual fund is Rs 40; hence Ram will get 1000/40 = 25 units. Now in the next month of Feb, the per unit value of the mutual fund goes down to Rs 34, now Ram will get 1000/34=29.5 units. Similarly in the next month of March the cost of the MF unit goes up to Rs 48, now Ram will be able to buy, 1000/48=21 units. Hence by the end of March, Ram would have acquired, 25+29.5+21 = 75.5 units, and the value of his investment would be, Rs 3624, on an investment of Rs 3000 over 3 months

What is the minimum amount I can start with?
Usually MF’s investment can start with as low as Rs 500.

Can I withdraw my money anytime?
Yes, if the fund you have chosen is an open-ended fund. There are closed ended funds also which have a certain lock in period. Such funds are also usually the tax saving funds

What kind of returns should I expect from a mutual fund?
MF’s are dependent on the underlying value of something. The mutual funds that are linked to equity markets or particular sectors have the underlying as the stocks in the market or the sector respectively. Usually one would expect that the MF’s do better than the markets, hence the expectation returns should be factored in accordingly. E.g. if the markets are giving you a 40% annualized return then it is not unreasonable to expect a 50% or more kind of a return from a good MF. However if the markets are giving negative returns then its not wise to expect your MF to double your money! Its all linked to the markets and the quality of investments that the MF’s make.


How much money do MF’s deploy in the markets?
Depending on the market scenario MF’s deploy cash. For e.g. I was just listening to an interview in CNBC with Mr. Madhu Kela, who heads one of the best MF’s in the country, the Reliance MF, he was saying that they are sitting on a cash of $1.5 billion, and they would deploy 100% cash in the scenario of NIFTY touching 4000. So it’s not a bad strategy on the part of the MF’s to also sit on cash and deploy it when the conditions become favourable. After all it’s a question of your hard earned money and the MF’s reputation. That’s why it makes sense to go with reputed names only