Investment may be defined as the application of money or money's worth in a process that begets more money. In other words, the multiplication in the amount of money, as a result of channeling the same through a process that adds incremental value to the original amount.
Many are the ways in which wealth may be created and multiplied. There are innumerable avenues for investment, each with a distinct purpose, and corresponding end result.One may invest in gold, or other precious metals like silver, platinum etc. One may invest in commodities like wheat, soy, corn, etc.One may invest in stocks of companies. Or one may invest in Mutual Funds (MF).
Definition of Mutual Fund (MF):
What is a MF? A Mutual Fund is a joint effort at Wealth Creation. Practically, a group of people come together and invest in a particular security / securities for common good. This group of people are banded together institutionally in the form of a fund, or an agency that takes care of their investment issues.
It is only logical then, that when a diverse group of people with different educational, cultural, economic and other backgrounds come together, there must be a common set of rules, customs, and practices to bring about harmony in their functioning, in order to achieve their common goal.
The legal constitution of a Mutual Fund (MF) depends on the laws prevailing in the country of its establishment. For instance, in the United States, MFs enjoy a special legal status. In India, they may be set up as Asset Management Companies, with Trustees running the day to day business. These Trustees are competent people who have thorough knowledge and understanding of the markets.
What MFs Do:
MFs are engaged in the business of collecting funds from the members and investing them in various stocks, securities, bonds, etc for the benefit of its members. Different strategies are followed by the MFs depending on their philosophy of investment, and the channels of investment available to them officially.
Types of Funds:
There are basically two types of funds, namely, growth funds, and income funds. Apart from these there is also the Tax Saving Fund.
A fund whose aim is to ensure a regular income to its members during the currency of the scheme. Accordingly, the MF chooses the type of companies to invest in, resulting in regular inflows of returns that are distributed among the members as per terms of the MF.People who require a regular income and are in a position to make the required investment would find this type of MF beneficial.
As the name indicates, the emphasis of the MF here is growth. In order to achieve this objective, the MF invests in companies that are likely to register fast growth over a relatively short period of time. As a consequence, the risk factor associated with this fund is also high.Investors who are not risk-averse and are willing to wait for a decent appreciation of their investments, without requiring a regular income, may choose to invest in this type of fund .
Tax Savings Fund:
Apart from the two types of funds discussed above, there is another type of fund offered by a MF with benefits in the form of tax savings, rather than income and growth. The rationale behind such a fund is "A Dollar saved is a Dollar gained."
Normally, these tax savings funds are operated under the auspices of some Governmental regime of tax concessions. That is, by investing in this type of fund, the investor is relieved of his tax liability to a certain extent. Investors whose main concern is to reduce their tax liability would find this fund attractive.
Benefits of Mutual Funds:
Two heads are better than one! What happens in a MF is that several heads come together and exercise their minds for mutual benefit. Some of the benefits accruing to members of a MF are:
Benefits of Capital:
Supposing there are 100 investors that want to invest USD: 1000.00 each in a particular activity. If they were to invest individually, each one would do so up to his own limit, and they would each benefit to the limited extent of their investment.On the other hand, if these 100 investors came together and pooled their investments and invested as one entity, then their investment of USD: 100,000.00 would fetch each of them, benefits of a USD: 100,000.00 investment, instead of a USD: 1000.00 one.
In the same way, a MF makes it possible for its members to invest in stocks and securities that would be out of their reach as individual investors. Large scale investments are brought within the reach of the small investors by breaking up the large investment into smaller parts or share.
Benefits of Expertise:
A lay investor may have an idea of investing, and what to do with his money. However, to maximize one's returns and to enjoy the benefits of investing to the full, one needs to have a professional knowledge of the various vehicles of investment, and also a thorough understanding of the market and how it functions.
This is where the expertise available with a MF comes to the fore. MFs are managed by professionals who know their job. By investing in a MF the investor is capitalizing on the expertise of the Fund Manager, and reaping the benefits of his investment.
Benefits of Diversification:
An investor, in his individual capacity, may not be in a position to invest in a bunch of diverse sectors, on account of his limited resources. However, by investing in a MF, he derives the benefit of investing in a cross section of activities and industries. By doing that, the investor, on the one hand, benefits from the upswing in any sector in the MF portfolio, and on the other hand, is not adversely affected to a large extent, on account of the spread of his funds in a variety of sectors.
Some of the other benefits of participating in a MF are tax breaks available in certain funds. Apart from that, a MF offers liquidity, in that, subject to certain restrictions, a MF member may encash his share of investment, in case of need. Further, the investor need not liquidate his entire holding, but sell only marketable lots, as specified, and retain the rest of his portfolio.The investor thus enjoys the benefits of holding a diverse portfolio without actually investing in each sector individually.
MFs, as vehicles of investment, have proved themselves to be versatile, catering to the small and the big investor alike. They do not require the investor to be investment-savvy to take advantage of them. In fact, they are meant for people who, either do not have in depth knowledge of the markets, or those that cannot spend the necessary time and effort to do extensive research, before investing.