Mutual funds

At PrimeInvestor, we love mutual funds and consider them to be an ideal investment vehicle for regular investors. We have several portfolios and recommendations tailored to mutual fund investors.

Mutual funds – a quick primer

A mutual fund is an investment vehicle that pools money from a multitude of people (investors like you and me). It uses this pool to purchase securities like stocks, bonds, and gold. As the prices of securities change, the mutual fund scheme makes its returns which is in turn the investor’s return. Professional money managers with decades of experience manage each mutual fund and take the call on which securities to buy and sell. The mutual fund is managed in a manner consistent with its stated objectives.

A mutual fund invests in a basket of securities. As the prices of these securities change (for stocks and some bonds) or as a fund earns the interest on the bonds it holds, its value changes. Gain in stock/bond prices sends value higher and vice versa. So as the fund value moves up, your investment value also rises.

When you sell your fund – In this case, you earn capital gain. Capital gain is the profit on your investment when you sell your mutual fund units. It is the difference between the market value of your mutual fund units at the time of sale and the cost of such units. The gains come in from the appreciation in your fund’s value. If the selling value is lower than your investment cost, you’ve made a capital loss.
When you earn dividends on your fund – This happens when a mutual fund declares dividend out of the accumulated profits it has made. This accumulated profit can be in the form of securities sold for profit, interest earned on bonds, or dividends earned on stocks.

Broad variants of mutual funds

Direct vs Regular Mutual Fund

A Direct plan is when you buy directly from the mutual fund company without involving a distributor. There are several platforms on which you can buy direct plans of mutual funds, in addition to an AMC’s website.

A Regular plan is when you use the services of a distributor or an agent, to whom the AMC pays a commission. This commission forms part of the expense ratio of a regular mutual fund. For this reason, a regular plan has a higher expense ratio than the direct plan and will generate lower return.

Active and passive mutual funds

In an actively managed fund, the fund manager picks securities with the aim of beating the benchmark. Securities in an active portfolio and their weights in the portfolio will differ from that of the benchmark index. In a passive fund, the fund manager simply replicates the index with exactly the same stocks and in the same proportion. The aim is to deliver only market returns and not beat it. Index funds and ETFs are passive funds.

Open ended and close ended funds

An open ended mutual fund allows investors to invest in and redeem from a fund at any time. The fund therefore receives perpetual inflows and redemptions. Investors are allotted units at the NAV prevailing at the time of investment. A closed-end fund is open for subscription only for a defined period, and investments need to be made only in this period. Closed-end funds also have a maturity date, before which investors cannot redeem their investments. However, in order to provide an exit route, closed-end mutual fund units are listed on stock exchanges, through which units can be sold to another investor. This route, however, sees very poor participation.

Articles on mutual funds

To start with, we have a set of articles that will guide investors about the basic concepts and definitions of this investment option. Here are a few: