Understanding Mutual Funds


A Mutual Fund in India is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities (stocks, bonds, short-term money market instruments, other mutual funds and/or commodities such as precious metals). The income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them.

The mutual fund will have a fund manager that trades (buys and sells) the fund’s investments in accordance with the fund’s investment objective.

Buying a mutual fund is like buying a small slice of a big pizza. The owner of a mutual fund unit gets a proportional share of the fund’s gains, losses, income and expenses.

The flow chart below describes broadly the working of a mutual fund:

(Source: http://www.amfiindia.com)

As you probably know, Mutual Funds in India are gaining ground & have become an extremely popular investment option. The fund industry has witnessed healthy growth in last five years or so.

The beauty of mutual funds is that you can invest a few thousand Rupees in one fund and obtain instant access to a diversified portfolio. Otherwise, in order to diversify your portfolio, you might have to buy individual shares, which exposes you to more risk and difficulty.

How safe is investing in Mutual Funds

In India mutual funds function as trusts. The sponsor of the fund appoints Board of Trustees who acts as guardians of investor’s money. The board or Trustee Company, as an independent body acts as protector of the unit holder’s money. These trustees ensure that investor’s interest is safeguarded and that the AMC’s operations and Fund Manager’s actions are along the professional lines. To ensure independence of Board of Trustees, SEBI mandates a minimum of two-third independent directors on the board of Trustee Company. Every mutual fund has a board of directors that is supposed to represent the shareholders’ interests, rather than the AMC’s.

Apart from Trustees, the entire mutual fund industry functions under the preview of SEBI. This structure and stringent guidance make investing in mutual funds safe and easy. Fund Managers also have to function within the broad framework and rules & regulations designed by AMC.

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