What You Should Know Before Investing in Mutual Funds
What is a mutual fund and how does it work?
We see and hear a lot about mutual funds being good investments from everyone. But what exactly are mutual funds and how do they work? Let's find out.
What is a mutual fund?
A mutual fund is a form of investment that is created by pooling funds from a large number of individuals, companies and financial institutions. In India, a mutual fund is registered as a public trust and managed by a fund manager who invests in diverse types of securities – equity, bonds, debentures, money market instruments and others. The types of securities invested in depend on the objectives that have been set out for the mutual fund in the offer document.
A mutual fund can add value to your investment in a couple of ways:
Capital appreciation achieved by selling.
This additional value that is generated is then shared among the entities that have pooled money for the mutual fund. It is distributed in the proportion in which people have invested their money.
Can a mutual fund manager do as he pleases?
No. The trustees of a mutual fund hold the assets on behalf of the unit holders who have pooled in their money. In addition, the trustees oversee the actions of the mutual fund manager and ensure that all operations as per the guidelines issued by the Securities and Exchange Board of India (SEBI).
How is the value of a mutual fund measured?
The value of a mutual fund is represented by its Net Asset Value (NAV). Since mutual funds redirect investor monies into securities, the NAV of a mutual fund is determined by the market value of the securities that the mutual fund has invested in.
The NAV of a mutual fund changes from day-to-day because the values of the underlying market securities also fluctuate every day. So the NAV for each unit is calculated by dividing the market value of the securities on a given day by the number of units of a mutual fund scheme. For example, if the market value of the securities is Rs. 500 lakhs and the mutual fund has 50 lakh units, then the NAV will be Rs. 10. However, remember that NAV is not an indicator of future performance. A higher NAV doesn't necessarily mean higher returns.
Finally, mutual funds, like all other investment options cannot be termed as 'good' or 'bad'. Whether an investment is good or bad depends on what you want from the investment. If your investment suits your investment goals, it would be safe to say it is a good investment. If not, it's probably not a good idea.