What is a Mutual Fund and why you should care about it

Mutual Funds are like the new restaurant that’s just opened up in your neighbourhood. You know that it serves six different cuisines, but you aren’t really sure which all taste good there. And there’s no feeling worse than choosing the wrong dish and having to finish it up!

Wouldn’t it be awesome if you could sample a little of all the different things they have to offer and then choose for yourself? Yep, except for one annoying thing: you have to buy the dishes whole. You can’t ask for a fifth of the Fondue and a third of the Dumplings. And your wallet doesn’t have enough for you to afford all dishes and let them go waste. 

But you really want to try the restaurant out. So, what do you do?

You call your friends! You call up six or seven of them, tell them about the new place and go out for the dinner. Now, with seven wallets on the bill, you can go ahead and try out all of those dishes you wanted to check out. Each of you gets to sample a little of each of the dishes and you’re all happy because even if you came across that one thing which sucks, the other five were decent enough to offset this. 

Mutual Funds are just like that. Only here, you are more often than not, the friend who gets called over. The person who calls you over is an expert who knows which seven dishes are the best bet you got from a menu of over a hundred. 

Say Hi to Ms. Simran. She has a lot of experience when it comes understanding the market and investing wisely. Now, she comes out and tells people that she has a portfolio of stocks, bonds and cash that she thinks is great and wants to invest in. For that, though, she needs to pool in money from different people so that she can have the benefit of large numbers on her side. To each one who puts their money into this pool, she promises to share the profits in proportion of their contribution. 

Suppose ten people decide to go along with her plan and give her some money. One person gives 18,000, another gives 10,000, while someone else gives just 1,000. Overall, she gets 1,00,000 in total, which is a good enough amount for her to invest in the portfolio.

She now splits the whole basket of money, which she calls a Mutual Fund (MF), into small units worth 10 each. So, the person who put in 18000, now owns 1800 units of Simran’s MF and is entitled to the profits that come from them. So, in this way, they are similar to owners of shares. 

Understand here that she is a pro at this. She is dead serious about making the most money out of this whole exercise. Maximising her profit is the only motive she has. And the only way she will make money for herself is when she makes money for all the people who have contributed to the MF. So if you are one of those investors, she is working real hard to make sure you get the most money out of it too. Hence, the word “mutual”. 

Now, at the end of each day’s trading, Simran sits down and figures out how much the MF is worth. One of these days, let’s say she sees that the value of the MF is 1,20,000. This means, each of the units of the MF has a value of 12, giving a return of 2 bucks per unit for all the investors. Everyone’s happy. Of course, if the MF goes into losses, everyone shares that as well, in proportion of the units they own. The “mutual” in the name makes people sink or swim together.

In short, the whole process boils down to this:

1. 1. A lot of people pool in money towards a common fund
2. 2. Each investor gets units of the fund in proportion of their contribution
3. 3. The fund is well-diversified and is professionally managed
4. 4. And finally, the investors share the profits or losses. 

There are a couple more things you should know too:

• You can enter and leave an MF at any time, but you might have to pay a small “exit load” on the way out if you are leaving the MF too early. 
• Before splitting the profits or losses, the managers of the MF will keep for themselves a profit margin and fee for their services. That is, the investors share in the gains from the MF minus the managers’ cut. SEBI has a cap on the profit margin, though, so you need not worry about the managers taking an over-large cut. 

So, all-in-all, Mutual Funds are a very good investment option when you are constrained by the restaurant-like problems we started the article with. MFs bring the benefits of large numbers to your side; they are diversified to optimise profit with minimum risk; and they are managed professionally. 

A final word of caution: Deciding to invest in mutual funds is the easy part. It becomes tricky when you have to pick the ones you want your money in. Mutual Funds come in all shapes and sizes, which makes things a little complicated if you don’t know how to make out one from the other. So, take a few days to learn more about this.

Did you know that you could save tax by investing in tax saving mutual funds? 

Wealthy is launching its tax-saver product in mid-week of December.

Please refer to our product's teaser tax.wealthy.in for a glimpse of how we intend to deliver this boring and painful experience of a 'must-do' financial activity