WHAT ARE MUTUAL FUNDS?
Imagine you had 100 Rupees to invest. You decided to divide them among stocks, debentures, debt instruments and bonds. You watched your portfolio as it went through its cycles of ups and downs. Let us assume that you invested in 5 stocks, 2 debt instruments and 1 bond, which means your share and debt market exposure was limited to these. Here, you or someone on your behalf will look after your portfolio.
Now let us take another scenario. You went to a Mutual Fund House also called an Asset Management Company ( AMC). HDFC, AXIS, NIPPON, ICICI, SBI all are AMCs. Your money was pooled in with millions of investors like you and institutional investors to buy stocks, debt instruments, debentures, government securities etc of 30 or more fundamentally researched companies, government sectors and portfolios. This wide range of skilled selection followed by trading and switching between profitable ventures over a time horizon constitutes a Mutual Fund. In Mutual Funds, the risk of the stock market is widely distributed among the various companies, sectors and financial instruments.
The Mutual Fund or an AMC is professionally managed by financial wizards and skilled experts of the field with in-depth knowledge and long-held market experience.
The investor money is thus invested and traded in the companies and sectors of the choice of the Mutual Fund Manager on your behalf. Instead of worrying about which stock or bond or commodity to invest in, your AMC will take up that responsibility with credibility and expertise for a small fee.
In this way, your 100 Rupees are now invested in not just 8 options but in 30 economically viable and fundamentally sound companies and sectors. As you can see, with the greater number of options, the principle of economies of scale will minimise your risk here. So your returns here will be from a combination of returns from 30 different and diversified ranges. Even if half of these do well, your mutual funds will give you a great appreciation above the traditional investments and also help you to beat inflation.