5 Key Benefits of Mutual Funds | Understand it with Example
Everyone would have seen the ads of mutual funds on TV lots of times and in the end, it says that involves risk so please read the documents carefully. But what is mutual funds?
I will explain it with example and will also describe important benefits of mutual funds.
Table of Contents
Understanding Mutual Funds with an Example
Let’s say you want to travel to Delhi from your place in car. So there are two ways you can go about it.
- You drive the car and go to Delhi (all decisions are taken by you like what route to go).
- You hire a driver or book a car from a professional travel service and they will take care of everything.
The same things happen with mutual funds. If you want to invest in stocks you can invest in your favorite stocks and you have to do the research about the stock before you invest.
Most beginners don’t know how to analyze the stocks so the best way is that mutual funds where you give your money to the fund manager and he is an experienced person who does research and invest your money in the stocks and you get returns from it.
Many individuals coming together (Mutual) and contributing their funds. And these people don’t have knowledge about the capital market but want to get benefited from the market so all their money is handled by a knowledgeable professional known as the fund manager who continuously monitors the market and invests in Assets, Bonds, Bills, Stocks, etc. according to the objective of the fund.
Type of organization that takes funds from people and invests in different avenues and get profit in the form of interest, dividend and they take a commission of 1-3% from the total profit earned and after that, they distribute the profit among the investors (people).
Every mutual fund has a Investment objective.
- Equity: Invested in the Stock Market.
- Debt: Invested in Debt so there is low risk and it never gets invested in the stock market so it’s independent from the market fluctuations.
- Balanced funds (Mix of Equity and Debt).
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Other Type of Mutual Funds
- Solution-Oriented Mutual funds:
You invest in a solution and you want that money after a particular period of time to solve the problem.
- Other Funds:
The most common example is Index funds where your money is directly invested on the Index i.e. the Sensex directly like Nifty.
Saving money is important for the future and so the mutual funds.
Parameters to Analyze the Fund
- Age of the Fund:
How old is the fund? The older the fund the better returns.
- Asset under Management (AUM):
The more the total value of assets under the mutual fund the better to invest in the fund.
- Historical Performance:
How much return the fund has given in the past. One should analyze the past 6 months, 1 year, 3 years, and 6-year returns.
- Standard Deviation:
From its average or the mean how much the fund has deviated this you can easily understand by seeing the graph. This helps us to understand how risky is the fund to invest.
- Sharpe Ratio:
Sharpe ratio tells more about the risk factor of the fund. This ratio essentially informs an investor how much more money he can make if he holds a risky asset. It basically tells about the returns generated by taking risks.
- Expense Ratio:
The lower the Expense ratio the higher the possibility of returns, This is the total fee charged by the fund manager to manage your fund. It is calculated by dividing total management fees by the total investment in the fund.
Benefits of Mutual Funds
Many people invest in risk-free investments like FD and Gold but the problem is as there is no risk or low risk the returns are also very less.But in mutual funds some level of risk is involved but according to that returns are also high.
Some of the benefits of mutual funds are-
- Handled with professional expertise:
They are handled by a team of experts who continuously analyze market variables and the economy and invest your money in the best place.
The money you invest can be easily withdrawn at any time you want. Only some mutual funds have lock-in periods. So in other investments like real estate and FD’s you don’t get this flexibility if it is there also you will lose the interest on your investment.
Freedom to choose your Fund, the amount you want to invest, and the time period. It’s perfect for any investment objective.
- Low commission investment option:
The commissions range from 0.5% to 1.5% on mutual fund investments.
- Good returns:
Most of the equity funds given good returns as these funds are investments in companies that directly contribute to the development of our Nation.
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Any doubt? Let’s discuss in the comment section.