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Financial Planning

Dummies guide to Mutual Funds

25 April 2017
Here’s why and how mutual funds can be a part of your financial portfolio!
 

You’ve surely heard the term ‘Mutual Funds’ before. But do you know why it’s important to find out more?

What are Mutual Funds?

Mutual Funds are just one of the many investment options available today. These are investment vehicles, in which you pool your money along with other investors. A fund manager then invests this on your behalf. You thus have access to a large number of assets, even if you pay a small amount. To know more, check out How Mutual Funds Work [Infographic].

Mutual funds are common investment options. In fact, in 2015, investments in MFs amounted to 7% of India’s Gross Domestic Product (GDP) - the measure of the economy’s size, as per a report by consulting firm EY. And this is poised to further grow.

In developed countries, MF investments amount to 91% (US) and 51% (UK) of the GDP. So, as the country grows to become one of the top three economies by 2020, MF investments are likely to grow too.

What this means is that your investments can grow too.

Your Mutual Fund returns:

As an investor, you can get your returns in two ways:

  1. Dividends

A mutual fund earns income from dividends on stocks and interest on bonds that are held in the fund’s portfolio. So, when these assets earn an income, the fund distributes its income in the form of dividends. These returns are offered regularly.

In fact, Monthly Income Plans, a kind of MF meant for regular dividend income, are one of the most preferred fund types in India. As much as Rs 55,219 crore has been invested in Income Funds, as of February 2017.

Related: Investing in Equities- Identifying the Best Plan for Your Financial Goals

  1. Growth option

You can also choose to reinvest your returns into the fund. This is a good idea if you know that the fund has greater potential to earn returns in the future. By reinvesting, you benefit from the compounding effect on your returns. This can increase returns over a long term. One simple reason for this is that the NAV reduces once a fund distributes dividends. So, overtime, the NAV of a growth option of the same scheme tends to be higher than that of its dividend option.

Related: How debt and equity based mutual funds differ in risk

Why are mutual funds important?

Mutual funds are one of the best investment options available today. As explained earlier, they have previously offered around 10-20% in returns. In certain cases that number has been higher.

The importance of investing in mutual funds can be illustrated by the following example.

As the country ushered in the new millennium, there was a great scope for people to increase their wealth through mutual funds.

During the period 2000-2016, a person who invested as little as Rs 100/month in the Reliance Growth Fund SIP would have earned an amount of Rs 1.5 lakh, as per a report by Business Standard. At the same time, an investment in a PPF would have yielded a return of Rs 45,000.

Related: ULIPs vs Mutual Funds- how do they compare?

This indicates the power of long-term investments in mutual funds.

Today, there are thousands of mutual funds in the Indian market that investors can choose from. For example, Unit Trust of India (UTI) is an Asset Management Company that offers more than 1,300 schemes to investors. Different schemes are tailored to suit different financial goals.

Related: Direct Mutual Funds- should you add them to your investment portfolio?

Impact on the economy

Mutual funds are investment vehicles—they help average investors buy stocks, bonds, money-market instruments, and even gold. So, if you put together all the funds, you get one of the largest institutional investors.

This means, any decision by a fund manager can affect stock markets, bond markets and maybe even gold prices.

The stock market plays a crucial role in helping companies succeed. Additionally, it helps people create wealth. All this affects the economy too. The bond market, meanwhile, can affect the interest rates in the market, and interest rates are vital for economic activities. By affecting both these markets, the mutual fund industry can play a big role in the economy.

Related: 4 Money management lessons you can learn from Donald Trump

Mutual Funds help understand trends

By observing a mutual fund, you can get a pretty good idea of how an industry or sector is performing. This is because a mutual fund reflects the value of the assets in the fund’s portfolio. The values of mutual funds change daily; they can go up on some days or go down on others. However, if the fund prices decline consistently over a period, then it is highly possible that the sector it tracks is also performing poorly.

For instance, a mutual fund that focussed on technology stocks would have performed exceedingly well until the dot-com bubble burst in early 2000. Investors realised that these companies were not generating profits and started to pull out their investments. This resulted in a decline in these mutual funds. As the value of tech funds started going down, many companies went out of business since they did not have adequate capital. This is how mutual funds have a direct impact on the economy.

Related: How your approach to money management should differ per job/profession

The bottom line

As an investor, you have various options to invest your money. But your investment capital can only earn income for you only if it is invested in the right avenue. So, choose the funds carefully before you invest your money.

 

Disclaimer: This article is intended for general information purposes only and should not be construed as investment, insurance, tax or legal advice. You are encouraged to separately obtain independent advice when making decisions in these areas.

 
 
 

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