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Mutual Funds are an excellent way to save for the future, and are a particularly smart choice of investment for women – They don’t require a considerable initial investment (the minimum amount required for investment for most mutual funds is as low as Rs.500), carry only a moderate amount of risk, and are also capable of providing a secondary income. Housewives, especially those who have a tendency to save in cash, will also benefit greatly from Mutual Funds because they will earn returns on otherwise idle cash savings.
If the idea of investing in mutual funds seems daunting, it’s probably because we aren’t clear on what they are, and how they work. Today, I will try to break down the what, why and how of Mutual Funds. Keep in mind that this is by no means an exhaustive guide, but I do hope that it sheds light on this popular investment option.
What is a Mutual Fund?
A Mutual Fund is a trust which pools the savings of a number of investors who share a common financial goal. The money collected is invested in different types of securities by the ‘fund managers’ depending on the scheme of the mutual fund. The income earned by the Mutual Fund is then distributed back to its investors in the proportion of their investment.
Let’s say you have four friends – Michelle, Madhavi, Kamala and Raji. All five of you are working women, and earn a decent income. Now, Raji’s aunt and uncle have a successful share-trading business, and they make great money. The idea of investing in the stock market is something that has appealed to all of you, but who has the time and energy to follow the markets all day?
One day, Raji comes up with a plan. She asks you all to give a portion of your savings to her, and she will consolidate these savings into one pool and give the total amount to her aunt and uncle, who will invest in the stock market on her behalf. Raji will then distribute the profits based on the proportion of everyone’s contribution to the total pool.
Raji is the Mutual Fund with whom you’ve entrusted the money, Raji’s aunt and uncle are the fund managers who invest the money so collected, and the rest of you, are the unit holders or investors.
Why should I give my money to somebody’s aunt?
Mutual Funds yield returns greater than conventional forms of investment – the average Fixed Deposit gives you interest at the rate of 7.5% a year, whereas there are plenty of Mutual Funds out there that give you more than 20% a year in returns. If you had one lakh to invest, you’d be making Rs. 7500 by putting it in an FD, as compared to Rs.20,000/- investing it in a Mutual Fund.
The reason why Mutual Funds fetch the returns that they do, is because they invest in a number of companies spanning across a variety of industries and sectors. This diversification, increases return, and reduces risk.
But what if I traded in the stock market directly?
There is no doubt that investing in the stock market directly will fetch maximum returns. However, trading in the stock markets also demands a heavy initial investment, which might be daunting for first time investors. Having the kind of diverse portfolio that Mutual Funds offer requires money, time and discipline. So, it really makes more sense to give your money to a Mutual Fund, which will provide the services of skilled professionals who watch the market closely, analyse the performances of companies, and then select the right ones to invest in.
Will they tell me where they’ll invest my money?
Yup. Every mutual fund is required to disclose their portfolio. If you’re interested in a particular fund, a simple Google search will reveal the companies and segments that it invests in, and the proportion.
Ok, I have one lakh. Tell me how this works.
Every Mutual Fund issues a certain number of ‘units’ that investors can purchase. The price per unit of a mutual fund is known as the NAV, or Net Asset Value. If you’re already holding units in a Mutual Fund, the NAV is what you’ll receive, per unit, if the Fund were to wind up that very day.
Let’s assume that the Mutual Fund you’re interested in, has an NAV of Rs. 250. With Rs. 1,00,000/-, you can purchase 400 units. You hold the units for one year. At the end of one year, the NAV of the fund is declared to be Rs.350, which means your investment is now worth Rs.1,40,000/- (400 units at Rs.350 per unit), giving you a return of Rs. 40,000 on Rs.1,00,000.
You receive your return based on the plan of the Mutual Fund you have invested in. If it’s a “Dividend Payout Plan”, the fund will pay you back the increase in NAV by declaring dividends from time to time.
In the “Growth Plan”, the returns earned by the fund, are retained in the fund, so your marker for returns is the increase in NAV. Dividend plans are suited for those looking for current income, and growth plans are for those looking for a long-term investment. There are also Dividend Reinvestment plans (where the dividend declared is used to purchase more units in the fund) and Bonus plans (where additional units in the fund are allotted, instead of dividend)
I’m sold! Now how do I buy into a Mutual Fund?
Buying units of a Mutual Fund is a lot simpler than it used to be. I will be sharing details of all the practicalities involved in purchasing units in a Mutual Fund including the broad varieties of Mutual Funds available in the market, where you can purchase them, what you will need to fill out the paperwork, and tax effects in next week’s post.
Rupee Rani is a weekly column on finance for women. Write to us with your queries at firstname.lastname@example.org.