What Is a Mutual Fund?
A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other securities. Mutual funds give small or individual investors access to diversified, professionally managed portfolios at a low price. Mutual funds are divided into several kinds of categories, representing the kinds of securities they invest in, their investment objectives, and the type of returns they seek.
How Mutual Funds Work
A mutual fund is both an investment and an actual company. This dual nature may seem strange, but it is no different from how a share of HDFC is a representation of HDFC Ltd. When an investor buys HDFC shares, he is buying partial ownership of the company and its assets. Similarly, a mutual fund investor is buying partial ownership of the mutual fund company and its assets. The difference is that HDFC is in the business of Financial Services, while a mutual fund company is in the business of making investments.
Advantages of Mutual Funds
There are a variety of reasons that mutual funds have been the retail investor’s vehicle of choice for decades.
- Diversification
- Easy Access
- Economies of Scale
- Professional Management
- Variety and Freedom of Choice
- Transparency
Types of Mutual Funds
Mutual funds are divided into several kinds of categories, representing the kinds of securities they have targeted for their portfolios and the type of returns they seek.
- Equity Funds
- Fixed-Income Funds
- Index Funds
- Balanced Funds
- Money Market Funds
- Income Funds
- International/Global Funds
- Specialty Funds
- Exchange Traded Funds (ETFs)
How do Investors earn a return from a mutual fund?
Income is earned from dividends on shares and interest on bonds/debentures held in the fund’s portfolio. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution. Funds often give investors a choice either to receive a cheque for distributions or to reinvest the earnings and get more units.
If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
If funds holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price (called NAV). You can then sell your mutual fund shares for a profit in the market.
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