Whenever I talk to a normal Indian who is not related to the financial field, one of the common questions they will ask is “What are mutual funds In India ” and how do mutual funds work in India? Honestly, it’s not rocket science and anyone with decent knowledge about fiance basics can learn,
Once upon a time…..
…..all villagers who hail from one of the intelligent parts of the country, gathered during evening hours, to discuss their day-to-day chaos.
The problem at hand today was that each of them had small money each day but did not know how to make the best use of it. The money was so small individually that none of the schemes accepted that money as an investment. The Panchayat decided to form a Group that would solve this problem.
Also Read: Types of Mutual Fund
The Group immediately proposed the solution. Let’s combine the money, and invest this money and the return shall be divided as per the proportion of investment. Villagers hooted… Wow good solution, but where would you invest the money? The group had some knowledge that money could be Invested in shares as but had a faint idea about it. Someone suggested let’s lend the money to someone and earn interest on it. But overall no one had the knowledge, so they decided to contact a wise person in the city who was well versed in the field of investments. So this, Wiseman accepted the challenge and came to the village.
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But FEW VILLAGERS had some doubts about this idea. Firstly, who would keep a check on the learned person and how they know that their investment is making money or running losses. The concerns were genuine and again the Group started thinking. They came out with Rules on investing the money. The Wiseman had to take prior approval from the group before investing and a few other rules on managing the money. But the second concern still remained, which was solved by the Wiseman himself. He said each day I would calculate & declare the value of the investment at a fixed time.
Beginning of a New Era
The scheme was launched and the news spread to all parts of the country. People from other villages were also allowed to join. Soon the group realized that they had to manage the record of so many people and solve their queries. They appointed a team of literate people and called it the Record Team who would just keep the record of the investors. Now the learned man complained that his entire day into managing the investments, taking care of the investments or getting the investments to the village, or sending the invested assets to the seller. Another team was appointed to assist him. This was called the Caretaker Team.
Up till now, the group was managing this show on funds issued by the Panchayat. But, now Panchayat told the Group since the scheme is a hit why don’t you start charging fees from the investment and earn on your own. This was a good idea Group laid rules for charging the Fees on the investments. And through these Mutual efforts, the villagers of this country had a prosperous life.
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Why Mutual Fund Emerged
Actually, through this analogy, we have just understood how a Mutual Fund works. As the name says, it is a mutual way of investing in Markets. They emerged because of two concerns faced by the Investors. First was the Quantum of investment, as people had small money to save on day to day or month-on-month basis. The second was the knowledge part as each of us has different education and profession, so we find our selves ill-equipped when it comes to investment Markets. So each of us needs the expert’s help during the investment process.
Organisation of a Mutual Fund
In the above story, the villagers are each of us and the Group is the Asset Management Company(AMC), who runs the entire affairs of the mutual fund. Since this group is appointed and answerable to the Panchayat, the Panchayat is the Sponsor of this Mutual Fund. The Wiseman appointed is the Fund Manager and his team who would take decisions in investing in different asset classes. The Rules laid are nothing but Objectives, which are set for each scheme, and the basic guidelines about the investment made under the scheme(Fund). The Value of investment that the wise man is reporting is the Net Asset Value or the NAV. NAV is the unit value of the asset and is calculating by dividing the assets by the numbers of unitholders.
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The Record Team is Registrar & Transfer Agent or R & T for short. They keep the record of the investors and take care of the queries of the units holders. And finally, the Caretaker Team is the Custodian, who shoulders the responsibility of keeping records and possession of all the physical assets of the scheme. And Fees that the scheme is charging are called the Asset Management Fees. All villagers were Investors. Simple… isn’t it?
Now, through the picture, you can very well correlate the working of the mutual fund.
Benefits of Mutual Funds
Now let’s discuss the benefits of investing in mutual fund. The biggest advantage is Diversification. Each units holder contributing in small proportion becomes the owner of a large portfolio comprising of different assets. He, therefore, minimizes his risk by dividing his investments in many securities. Other advantages are, though mutual fund you and expert managing your investment. Also, you can invest in small amounts. Since this is a collective investment, the cost of management is very low and most important the liquidity aspect. Mutual Funds have schemes as per the time horizon of your investment. So you can get your money back when the need arises.
In the subsequent series, we shall learn more about Mutual Fund’s benefits, types and how to choose & invest in these schemes.
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