Definition:

A mutual fund is a professionally-managed investment scheme, which is administered by an asset management company under the supervision of a fund manager or money manager. This company brings together a group of people who invests their money in stocks, bonds, and other securities for better profits. 

(Insurance or Mutual Fund! Which one is better option for investment?)

In simple words mutual funds are investment instruments that allow a group of investors to pool their money together with a predetermined investment objective of profits. The mutual fund will have a fund manager who is responsible for investing the pooled money into some specific securities (usually stocks or bonds). Mutual funds are one of the best investments ever created because they are very cost-efficient and very easy to invest in (you don’t have to figure out which stocks or bonds to buy).

How does it work?

A mutual fund is a collection of stocks, bonds, or other securities owned by a group of investors and managed by a professional investment company. For an individual investor, having a diversified portfolio is difficult. Mutual funds help individual investors to invest in equity and debt securities simultaneously. When investors invest a particular amount in mutual funds, he becomes the unit holder of corresponding units. In turn, mutual funds invest unit holders money in stocks, bonds, or other securities that earn interest or dividend. This money is distributed to the unit holders. If the fund gets money by selling some stocks at a higher price the unit holders are liable to get the capital gains or profits.

Advantages of mutual funds

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Professional management :

By investing in mutual funds investors can build wealth with professionally managed schemes or funds. This includes defining investment opportunities as per objective. Making informed decisions of investment. Investing in well-researched markets and securities. This allows investors to invest in the securities market without any knowledge about security markets which also saves time of investors with very little expenses.

Diversification at an affordable price :

Mutual fund schemes offer diversification of investment with a minimum investment of Rs. 500. By investing a small amount investors can invest in all securities held by scheme portfolio this reduces the risk of capital loss. For example an equity mutual fund scheme holds around 30 to 50 stocks and you are investing in all these stocks with Rs.500 only. But when you are investing in the stock market individually. You are not even able to purchase a single share of some companies. This is a great advantage of mutual funds.

Low expenses on investments :

As mutual funds pool money from a large number of investors it allows to engage professional fund managers to manage investments. Individual investors with a small amount of investment can not afford professional management. The expenses of fund management are divided into a large number of investors. It is very economical for small investors.

Liquidity :

Mutual fund schemes offer high liquidity to investments due to the large number of investors which allow fund managers to interchange assets under management.

Tax Benefits :

Some schemes called equity linked saving schemes (ELSS) and it allows investors to save income tax under section 80C. Investors can take benefit up to 1.50 lakh of investment in ELSS schemes in the financial year.

Limitations of Mutual Funds

Customization of Portfolio :

Portfolio management services (PMS) allows portfolio customization for high net worth investors. But Portfolio Customization is not offered in mutual fund due to investments are managed by fund managers.

Choice of Mutual fund scheme :

As there are a large number of schemes available in India. Around 47 asset management companies are offering more than 2000 schemes. It becomes difficult to choose the right schemes for investors. Investors should take guidance from experts for scheme selection.

No control over expenses :

An investor has no control over Expenses made by asset management companies.

Market Linked Investment Instrument :

A mutual fund is an instrument which is a market linked product, so it bears the risk of market fluctuation time to time.

Note: The content of the article is collected and read from various sources from the internet and knowledge gathered from 14 yrs of  banking experience.