What Are Mutual Funds?
Mutual fund refers to a large pool of money invested in proportions, in the stock exchange by sound professional expert known as the finance manager.
Mutual funds are ideal for investors who either lack large sums for investment, or for those who do not have the time to research the market, yet want to grow their wealth. The money collected in mutual funds is invested by professional fund managers according to the scheme’s stated objective. In return, the fund house charges a small fee which is deducted from the investment. The fees charged by mutual funds are regulated and are subject to certain limits specified by the Securities and Exchange Board of India (SEBI).
Actively managed mutual funds refer to those funds which are actively and attentively managed and monitored by the financial experts, whereas, Passively managed mutual funds refer to those which have a set of predefined rules and regulations. Comparatively lesser fees are charged by these financial experts.
Mutual funds are started by the Asset Management companies. Investment of money is a complex decision, finding the right avenues, the rate of return, significant timeline are the major elements or factors which need to be taken into consideration.
Net Asset Value (NAV):
- NAV abbreviation stands for “Net Asset Value”. The performance of a specified mutual fund is denoted by its Net Asset Value (NAV). As shares have a market traded price, similarly, mutual funds are assigned a net asset value per unit. The NAV of mutual funds fluctuates daily depending on the performance of the underlying assets. It is required to be disclosed on a daily basis.
- The NAV per unit is the market value of securities of a particular mutual fund divided by the total number of units of the scheme on any specified date.
NET ASSET VALUE (NAV) = Fund Assets - Fund Liabilities / Total Number of Units Outstanding
Advantages of Mutual Funds:
- Diversification: Mutual funds help in the diversification of funds to various sources by putting the entire money in a single place.
- Expert Supervision and Management: Mutual funds are monitored and managed by financial experts which monitor and supervise the performance of the fund.
- Liquidity: Mutual funds provides with the advantage of liquidity of funds. In Economics, liquidity refers to something which can be easily converted into cash. One can redeem the mutual funds as and when required.
- Reduced Risk: Due to the factor of diversification the risk associated to investments is reduced significantly.
- Tax Advantage: There exist mutual funds which are primarily concerned with providing tax benefits and concession in regards to income Tax. By making investments in such particular mutual funds one can avail the facility of tax advantage.
- Low Operating Costs: The cost associated to operation of mutual funds is considerably low.
- Higher Returns: Mutual funds have a history of giving higher returns in comparison to any other financial instruments.
- Investor Protection: Mutual funds work within the framework of the stock exchanges or capital markets which are regulated by the Securities and Exchange Board of India (SEBI). SEBI protects and promotes the interest of the investors.
The biggest advantage of mutual funds in comparison to any other financial instrument is that it is already diversified. The probable risks associated are reduced due to the factor of diversification. Investment in mutual funds is affordable as the units are available at nominal net asset value (NAV).
Disadvantages of Mutual Funds:
- Exit Load: Mutual fund companies levy an exit load (charge) when the redemption is done within a specified period, for example, within one year from the date of such investment. This policy is laid down to refrain the investor from exiting the scheme too early, it will not only have a negative impact on the mutual fund’s performance but also lead to negative or less returns to the investor.
- Risk: The investment in mutual funds is linked to the stock exchange and investment in securities market are subject to market risks. One has to anticipate the losses, mere diversification does not give a complete hedging from the risks. For example, investment in equity mutual funds are subject to volatility due to the fluctuating market conditions.
- Finance: After the issue of NFO, the received funds need to be invested which is the core element of the mutual fund scheme, this primarily defines its performance. The finance manager has to do extensive research and take sound financial and investment decisions inorder to make good returns.
What Is A SIP?
- The abbreviation SIP stands for Systematic Investment Plan, this is a type of investment which helps the investors save and grow the investors’ money over a period of time. SIP helps investors to invest small amounts of money on the regular basis instead of investing a large sum of money all at once. It primarily gives the benefit of the term Rupee Cost Averaging and works on the foundation of this approach. Investing in SIP provides with the benefit of averaging out the costs of the investments without having to worry about the market conditions.
- SIPs are a convenient and flexible way to enter into mutual funds and provides with the choice for the investor regarding how much, how often and how long to continue investing. The mechanism of mutual funds is quite simple, the investment amount automatically gets deducted from the investor’s bank account each month so there is no need to worry about making manual mutual fund investments. SIP is a great option for anyone who wants to invest in Mutual Funds but does not have the lump sum amount to invest, the time and knowledge to monitor the markets.
- The primary motive behind SIPs is to average out the cost of investments over a certain period of time. For example, if there is a same amount of investment of money each month, one will purchase more units when the price is low and fewer units when the price is high. This simply indicates that one will end up paying an average price for all the units purchased which will help to maximize returns in the long run and provide with the advantage of compounding.
Mechanism of SPI:
For example, ‘A’ has rupees 2,40,000 and wants to invest in the mutual funds and the prevailing market conditions are fluctuating. Hence, ‘A’ is advised to start an SIP inorder to get the benefit of rupee cost averaging. So, rather than investing rupees 2,40,000 all at once ‘A’ can invest rupees 20,000 on the monthly basis for a period of 1 year.
ADVANTAGES OF SIP:
- Rupee Cost Averaging: The term Rupee Cost Averaging is inspired by the approach of Dollar Cost Averaging. The approach of Dollar Cost Averaging was first introduced to us by Benjamin Graham, in his book, “The intelligent Investor”. Rupee Cost Averaging gives the advantage to the investors to invest small amount on a regular basis which helps to average out the costs of their investmentin the long run. For example, Investors invest rupees 10,000 in shares of SimplifiedFiscalAffairs Ltd. which were worth 10 shares (rupees 1000 per share). Similarly, as the price of the shares increase the shares purchased are fewer, as they get expensive. So, when the investors invested ten thousand rupees next month, investors ended up buying only 8 years for the same price. In the consecutive month, the price decreased and investors purchased 12 shares. Hence, when the markets were expensive, the investors got lesser shares and when markets where cheap investors got more shares at a discounted price. This approach helps investors average out the cost of investment by simply following a regular and disciplined strategy of investing over a period of time.
- Disciplined Strategy: Discipline is the primary element required in the mechanism of SIP to create a significant corpus in the long run. SIP encourages a disciplined approach to investing by requiring the investors to set aside a fixed amount of money on a regular basis. The discipline of investing leads the investors to reap the benefits of wealth compounding.
- Convenient: Systematic Investment Plan is easy to set up and manage. Investment amount is automatically deducted from the investor’s bank account each month. Hence, there is no such need to make manual Investments. This element of convenience makes SIP a convenient option for investors who are busy or don’t have the dedicated time to manage their investments actively.
- Liquidity: Systematic Investment Plan is a strategy whereby, a person makes regular and systematic monthly investments as per his convenience and ability but it can be stopped as an when required, there is no such compulsion or lockin period unless and until specified. One can redeem the investment amount and stop the SIP as and when required.
- Flexibility: The investment in SIP is a flexible approach, it offers the investors to choose the amount of investment, the frequency and the duration/tenure of the investment.
- Cost Efficient: Investing through SIP is cost efficient as the investment amount is small and the investment management fees are spread over a long period of time, therefore, reducing the impact of the costs on overall returns.
- Diversified Portfolio: SIPs are managed by expert financial managers who make sure to diversify the portfolio across various financial segments. Diversification reduces the risk of investing in a single security. It further helps to balance out the portfolio and reduce the risk of losses due to market volatility. This is another great advantage of making investments in SIP as, not only a smaller amount is required to start an SIP at a nominal NAV (Net Asset Value) but also along with the benefit of diversification which helps to earn great returns and at the same time mitigates the risk because of the factor of diversification.
- Professionally Managed: Mutual Funds are managed by trained professional financial experts. Investment in SIP provides with the access to professional investment management which helps individuals make strategic investment decisions in order to achieve their financial goals in a significant duration.
- Long Term Advantages: Investment in SIP makes great returns when it is done for the long term. It is a great option for long term investment as it allows individuals to invest regularly over a long period thereby, taking advantage of the power of exponential compounding. The returns on the investors investment get reinvested resulting in the exponential growth in the long run, again the principle of rupee cost averaging provides with the great benefits of exponential compounding.
