Indirect way to invest in stocks –Mutual funds.

What is it?

The term itself gives some hint about its nature. “Mutual” means combined and “Funds” means money. So, mutual funds are the collective investment contributed by many investors and managed by professional individual or company (your fund manager). The fund manager invests this combined money in stocks, bonds, short-term money market instruments, and/or other securities

What’s the advantage?

  • You do not have to constantly keep an aye on the stock market. The fund manager will invest the funds wisely and in profitable companies.
  • The funds are invested in various companies and that too by the professionals. So, you are not keeping all your money in one pocket. This minimizes the risk of huge loss investment loss. Even your Rs 5000 invested is diversified.
  • You can plan and invest systematically. (That can be done in share markets to, but SIP process in mutual funds works well)
  • Unlike companies, mutual funds will not close down. Rather they would be merged into another successful fund
  • Normally the NAVs do not show a significant rise or crash

Any Disadvantages?

  • You don’t have a say in deciding where your money is invested. The fund manager decides for you and he may be wrong, thus causing a loss
  • You don’t own shares directly, so you are not eligible for any rights due to the owner.
  • Dividend is optional and if chosen will affect the value of your investment by the amount of dividend declared

Scheme philosophy

Whenever a mutual fund scheme is launched there is a specific mandate (philosophy of investing) based on which investing is done by that mutual fund. This mandate outlines the debt-equity mix and the type of instruments that the fund would invest.For example, the prospectus of a mutual fund will always mention the stock universe that fund invests in viz, large cap, mid cap, small cap, sector funds etc.. or it will have a ‘theme’ for example –  ‘energy opportunities fund’ or ‘emerging leaders fund’ etc.. From the name itself,you could get a basic idea of where your money will be invested. Since Mutual funds offer a whole bouquet of products ,  you must first decide on the types of funds that would suit your needs. Only then should you start selecting the best funds within those categories.

NAV and it’s importance.

Net Asset Value, or NAV, is the sum total of the market value of all the shares held in the portfolio including cash, less the liabilities, divided by the total number of units outstanding. Thus, NAV of a mutual fund unit is nothing but the ‘book value.’

The NAV of the fund has no impact on the returns it will deliver in the future.

  • For example – Let’s assume you plan to invest in an index fund and you have two choices - Fund A is a new fund with an NAV of Rs. 10, which will mimic the Nifty and a Fund B, which is an existing Nifty index fund with an NAV of Rs. 200.
  • Suppose you invest Rs. 10,000 in Fund A and Rs. 10,000 in Fund B. You will get 1000 units of Fund A and 50 units of Fund B. After 1 year, if the Nifty has appreciated by 25%, it means that both funds would have also appreciated by 25%, as they are a replica of the Nifty.
  • So after 1 year, the NAV of Fund A would become Rs. 12.50 and that of Fund B Rs. 250. But what is the value of your two investments? Fund A would now be Rs. 12,500 (1000 units * Rs. 12.50/unit) and Fund B also would be Rs. 12,500 (50 units * Rs. 250/unit).

The bottom line is that don’t bother about the NAV of a mutual fund, as you might do for the price of a share.

As with any investment, there are risks involved in buying mutual funds. These investment vehicles can experience market fluctuations and sometimes provide returns below the overall market. You may consider investing in those companies belonging to the top performing mutual fund companies. This gives you some security that the company is able to increase your capital investment. To know if the company is performing well you can ask for feedbacks, past performances etc.

You may like these posts:

  1. Should you invest or trade in stocks?
  2. How much money should you invest in stock markets?
  3. Where can you invest?

2 Responses to “Indirect way to invest in stocks –Mutual funds.”

Yogesh Gajria

October 29, 2012 at 11:41 pm

Hi Mr. Victor
First of all, its great to have this kind of information for beginners. I really thank you for this effort. Great job!!
I have a doubt in this article. Like if Fund B has NAV of Rs. 200 and I am investing Rs. 10,000. Then won’t I get 50 units instead of 20?
Please check it. I may be wrong. In that case, I hope you could explain me.
Thanks once again!

J Victor

October 30, 2012 at 7:38 am

Hi Yogesh. Thanks for noting that. The mistake has been corrected.

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