What the Hell Are Mutual Funds?

Hmmm.. Lately, you have been hearing a lot about Mutual Funds, everyone seems to be talking about it. And every financial institute, ranging from banks to PMCs seem to be offering these. But, what the hell are these.

So, let's start with the most basic question, "What are Mutual funds". And we'll demystify this down the line. In simple language, mutual funds are a pool of funds. Lot of like minded investors pool their money together. They than hire a professional fund manager to play around with their money. The fund manager is responsible for managing the money. He decides where to invest the money, when to invest and when to book profits. He is the one who is in complete control. And the profit(or loss) that he makes on the investments is shared among the investors in proportion of their investment. Advantage of such a fund is obvious. Money is managed by a professional fund manager who has better knowledge than a normal investor, and investor is freed from the worry of managing money at all the time. The worries are taken care by Fund manager, and investors just sits back and reaps the benefits( or losses, in some cases.)

A lot of fund houses have come up globally that offer mutual funds. These fund houses launch mutual funds in same way as companies launch their stocks. These fund houses charge a lot of different kind of fee from investors who wish to put money in mutual funds. Fee is in form of entry load, exit load and fund management charges. But for a good fund, these charges would be negligible compared to the returns offered by the mutual fund.

As the stocks are traded at stock prices, similarly mutual funds also have a price associated with them called NAV or Net Asset Value. When fund houses launch mutual funds, they define rate of a unit of fund (mostly $1). Then as the investments made by the mutual fund grows or decrease, the rate of a unit increases or decreases proportionately. Investors buy or sell mutual funds based on their NAV only.

NAV is also a good indicator of mutual fund performance. The mutual funds whose NAV increases more are better than the ones with lesser growth. But while judging mutual funds using NAV, we need to look at a bigger time horizon ideally 3-5 years. In short term the funds may fluctuate a lot, and that might not be an indicator of their true performance. However, a bigger time horizon gives a true picture about the fund stability and returns. Apart from NAV, there are some other factors also that need to be considered such as the performance of the fund house, performance of other funds managed by that fund manager, and quality of the portfolio being held by the fund.

Investors buy or sell units of mutual funds in the same way they buy or sell stocks. As with stocks, if you want to realize true returns from mutual funds, you must stay put in them for a longer period. Ideally this period should be above 3 years.
There are a lot of different kinds of mutual funds available. Funds range from Equity diversified that primarily invest in stocks, balanced funds that invest in both stocks and bonds, and debt funds that invest primarily in debt instruments such as bonds. Investors can choose the one that fits their risk appetite. Risk taking investors may like to go with equity funds, which offer a chance of making larger returns albeit at a higher risk. And risk averse investors may like to go with Debt funds. These offer lesser returns but almost zero risk. I will cover more about different kinds of mutual funds in my some future article.

So, in a nutshell, if you have money but do not have time and/or knowledge to monitor it , then mutual funds are the way to go. They are like an investor's dream. You put your money in them, than forget about it and go to sleep, wake up after some time and reap the rewards. I don't think it can get better.