Good and bad, right and wrong – it is always important to know about the two sides of everything. If not, life would never go on. Just like that we are here to talk about another aspect whose two sides you definitely need to know. That is mutual funds. Get ready readers, know the perks and the risks of investing in mutual funds. Along with the long list of different kinds of mutual funds out there.
What is a Mutual Fund?
A mutual fund is a kind of investment where the money is pooled from different investors to purchase a diversified portfolio of securities like stocks, bonds, money market funds, and more. Mutual funds are managed by professional managers who make the investment decisions on behalf of the fund’s shareholders. The core characteristics of a mutual fund are:
- Mutual funds invest in a multitude of securities.
- Experienced fund managers are the decision-makers.
- Mutual funds are usually quite easy to buy and more accessible.
- There are many types of mutual funds available to different kinds of investors.
- Mutual funds have various costs associated with them.
- Mutual funds are regulated by a government agency known as SEBI.
Types of Mutual Funds
There are different types of mutual funds which are mentioned below:
- Equity Funds
These funds typically invest in stocks, and they aim for overall capital growth. They could be further categorized as growth funds, value funds, and even income funds according to their strategy of investment they follow.
- Bond Funds
Bond funds invest in debt instruments and concentrate specifically on generating income with interest payments.
- Money Market Funds
They invest in short-term and low-risk securities like T-bills and commercial papers. They aim at offering liquidity and preserving capital.
- Balanced Funds
A balanced fund would invest in a mixture of stocks, bonds, and various other assets to offer a balanced approach to growth and income.
- Index Funds
They target to mirror the performance of a particular index, such as the S&P 500, by investing in the same securities as the index.
- Sector Funds
Sector funds concentrate on specific sectors of the economy, such as tech, healthcare, and energy.
- International Funds
These funds typically invest in securities from markets outside the investor’s home country, in our case, India, and they provide exposure to global markets.
All these different funds cater to different kinds of needs for an investor. Now that you have understood what is mutual fund and its different types, let us understand the perks and risks associated with it.
Perks of Investing in a Mutual Fund
There are various perks of investing in mutual funds, and the main kind of perks are:
- Mutual funds are easily accessible to a broad range of investors, and they often have a low or the least investment needs. This makes them an easy option for individuals too start investing.
- By pooling money from different investors, the mutual funds could be invested in a large and more diverse portfolio than an individual investor might be able to on their own.
- They come with ease, and convenience for an investor. They offer the path to diversification without having to manage different investment requirements.
- Investors get to benefit from the experience of the expert fund managers who would be making investing decisions according to detailed research and analysis.
- Mutual funds let you take advantage of the economies of scale in transaction costs and other expenses. They can be more cost-effective than individual investing.
- Mutual funds are subject to the regulatory oversight, and they must regularly disclose their holdings, performance, and fees, providing transparency to investors.
Risks of Investing in Mutual Funds
While every coin has two sides, you also need to know that there are risks too when you invest in mutual funds.
This does not mean you completely stay away from mutual funds, instead you need to be aware of these risks to manage them effectively.
- Market Risk – The mutual fund’s value can change in the overall market condition, and this could be because of the economic development, interest rate changes, and political events that could affect the market sentiment.
- Interest Rate Risk – The change in interest rate could affect the value of the bonds held in a mutual fund, and when the interest rate rises, the value of the bonds falls. This is a risk you need to look out for.
- Credit Risk – This is relevant for most funds, particularly bonds funds. It means the possibility for the issuers of the bonds in the fund’s portfolio any default on their payments, which could lead to a loss in value.
- Inflation Risk – Inflation could erode the purchasing power of the returns that are generated by a mutual fund. So make sure you outgrow inflation.
- Management Risk – Mutual fund performances are based on the skills of the fund manager, make sure you do a thorough research of the fund manager before you begin.
- Liquidity Risk – Some mutual funds would invest in securities that are not easily sold, especially in times of market stress. At this point, you need to choose funds based on your investment horizon.
- Concentration Risk – When a mutual fund is only concentrated on one particular fund, then you need to be aware of how much risk you can handle, since one shift can affect the entire portfolio as a whole. This means you need more diversification.
- Expense Risk – While mutual funds offer professional management, it is inevitable that they would have some costs associated with them.
Conclusion
Now that you know everything about a mutual fund, what it is, how it works, its main features, the different types, its benefits and its risks – you can set foot in this field with a bit of expertise. Happy investing folks!