MUTUAL FUNDS (BASICS)
Mutual Funds are something we often hear about in the advertisements, in news, like we often hear that stock market is risky, but mutual funds are comparatively less risky and you get better returns compared to other investments but do you pay attention to the star mark at the end which states “mutual funds are subject to market risk”, so today we will discuss on this particular thing. In the previous blog of Vyolvepaisa, we discussed about Stock Market Bubble, which we will study in more details. Also, we will split Mutual Funds into various parts for your better understanding, but for today we will understand the basic concepts of mutual funds.
So without wasting much time, let’s get started!
Let’s understand this story for the actual understanding of Mutual funds. Let’s say you have a friend and he is well-versed with the stock market understanding regarding every sort of investment and all the people around this guy are well aware of the profits that the person gets with investing in the stock market. Everyone knows that this person earns more profit by investing in the stock market as compared to the others who invest in banks. Now what you will do, you will go to your friend with your money and ask him to invest your money in the stock market, on your behalf, and the profits that will be earned out of the investment will be divided into portions between both of you in a certain ratio, which both of you agreed upon.
So you gave your money to your friend and he will invest in the stock market on your behalf, he will study about the market and analyze the market trend and he will invest at a place which he will consider to be the best one. So in this, he will invest and at the end of every month, he will give you some percentage of the profits that he will incur. Say, he invested Rs.1 lakh on behalf of you and he got a profit of Rs.10,000 on 1 lakh, say you both have signed a deal, stating that the profits will be split into 6:4 ratio i.e 60% of the profit will be yours and your friend will have remaining profit. In this case, Rs.6000 will be your part of profit and Rs.4000 will be your friend’s part, because all the study and market research is done by your friend.
Now let’s get back to practical life. Here, Mutual Fund is just like your friend, who will invest your money in the stock market on your behalf, but yes, there are risks, definitely, if the stock market shrinks, then your mutual funds will also lose its value because your money is invested in the stock market.
Now we often hear that the stock market is risky, but comparatively, mutual funds have less risk. Now what they mean to say is stock market will be risky when you yourself will be doing the investment, because then you will have to study about the market, its parameters, its movement, etc. So it’s about, the better understanding you have about the market, the more better-investing decisions you can make.
And then there comes the problem that there are many people invest without thinking or understanding the concepts, then there is a risk like we discussed in the Stock Market Bubble. Now what happens in Mutual Funds, the one who is investing on behalf of you is having the proper knowledge of mutual funds, that is his work, so will study the market, analyze the patterns, and then will create a portfolio, by deciding the appropriate stocks that he will consider better for investment. By portfolio, they aim to diversify the risk which will help us in achieving better returns.
So Mutual Funds is the investment of your money in the stock market on your behalf, and definitely, they carry risks, it’s just that if you are doing it yourself, without understanding the concepts, then the risk is more and if an expert is doing it on your behalf, then the risk is less. So this is the basic concept of mutual funds.
Now how do you set-up a mutual fund?
It is not like anyone who wants can enter randomly into it. Let’s assume that there is a company and there are various workers who are fund managers, who will take your money and invest in the stock market, then such companies are termed as Asset Management Company (AMC). But it is not possible to set up a company and start your investment right away, it also requires a lot of procedure for the setup of an AMC because the money of the public will be involved, the government will be precautious as well. And for this, SEBI has issued a lot of guidelines that are required at the time of opening AMC.
Now let us understand AMC in a little detail. Now let’s assume that TATA wants to open their own AMC, so TATA will approach SEBI. And then SEBI will approve whether TATA will be liable for the AMC or not. Now when SEBI will give its clearance to TATA that they can establish their AMC, now TATA will appoint a trustee, the trustee here will ensure that the AMC is performing properly, but it should not be a biased one, the trustee should not be the company of TATA itself, otherwise, it might turn out to be a biased one. TATA here is just a part of the illustration, it can be any company.
Now the AMC has been established, and there will be fund managers, researchers who will have a proper understanding of the stock market, people from sales, operations, and many more fields.
We will split AMC into three parts. RTA, they will look into the client-side, at what prices the shares are available to the general public, say this particular person is having such value of mutual funds. Next is an operation, say sales. Now next one is the important one. When you are investing, you want someone to keep your money safely, and which is done by Custodian, who keeps your shares or money safely, say mutual funds have purchased many stocks, then they have to keep it preserved.
This is clear enough that Mutual funds are as risky as the stock market, the difference is just that, when an expert invests on behalf of you, then the risk is comparatively less, but if you feel that you have adequate knowledge of the stock market and you have time to read the stock market, then you can earn higher returns, but if you don’t have time to study the patterns of the stock markets, and you just want to invest your money, then Mutual Fund is a better option.
So this was the basic level explanation of Mutual Funds. In the next episode of VyolvePaisa, we will discuss the types of mutual Funds, like small-cap, mid-cap, large-cap and much more. And also we will put emphasis on the mutual fund’s investment as a beginner.
So that’s all form Vyolve Paisa for today. Stay tuned for the upcoming Financial Concepts.
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