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Last Updated : Nov 29, 2019 04:56 PM IST | Source: Moneycontrol.com

Classroom | What are mutual funds and why should I invest in them? (Mutual funds: Part 1)

Mutual funds are investment vehicles designed for the small investor. It is an instrument that pools in money from several investors and collectively invests it in equity and debt markets. It is not an investment, per se. It’s a vehicle that channelises your money into equity and debt markets.

Moneycontrol PF Team

As part of our Classroom series, Moneycontrol brings to you an easy-to-understand guide on mutual funds. In Part 1, we answer all the basic questions you may have had, but did not know whom to ask.

There was a time when our parents used to buy equity shares of well-known, established companies and then hold them for a long time. Many of us would have inherited some of those bluechip shares even. But how investors have held equities has changed over the years. Consider this. National Securities Depository (one of the two depositories in India) has 1.89 crore demat accounts, as of 31 August 2019. The other depository, Central Depository Services (India) has 1.93 crore demat accounts. On the other hand, the Indian mutual funds industry boasts of about 2.14 investors (or as the industry recognises as ‘unique permanent account numbers’). Clearly, the Indian mutual funds industry has come a long way.

From managing investor assets worth around Rs 97,028 crore at the start of the 2000, mutual funds today manage assets worth a staggering Rs 26.13 trillion. Although mutual funds have been around since 1987 (Unit Scheme 64, though was launched in 1964 but under a special Act of Parliament and therefore was out of the regulator’s ambit until 2001), people started investing by the droves only in the last decade. The note ban of 2016 and the super-successive campaign ‘Mutual Funds Sahi Hain’ took mutual funds to the masses. However, less than 2 percent of India’s population invests in mutual funds. In simple words, not many of us understand what a mutual fund really is.


What is a mutual fund?

A mutual fund is an instrument that invests your money in the equity or debt markets. It is not an investment, per se. It’s a vehicle that channelises your money into equity and debt markets. It pools in money from several investors and collectively invests it in equity and debt markets.

But why should I go through a mutual fund? Can’t I invest in equities and debt on my own?

Of course you can. But that is fraught with risks. For instance, which company’s shares do you buy? How do you zero-in on such companies? Can you study annual reports, profit and loss numbers, decipher industry trends well enough to make an informed decision? Also, individual shares prices may not come cheap. How many shares, for instance, can you buy for Rs 5,000? Barely a handful, right? The problem is bigger when you wish to invest in debt markets. High investment limits and the lack of easily available of bonds have made it virtually impossible for investors to invest directly in debt markets.

Do I need a lot of money to invest in mutual funds? I heard only the rich invest in them.

No you don’t need a lot of money. Because several investors get to pool their money together, the minimum investment in a mutual fund is also as low as Rs 5,000. In some cases, it also comes down to Rs 1,000. Mutual funds also employ full-time professionals whose main- and only- job is to research on companies and industries so that there is a solid reason behind their investments. In fact, if you enroll for a systematic investment plan that allows you to invest a fixed sum of money every month, then you can even invest Rs 500 a month. Mutual funds are investment vehicles designed for the small investor.

You may not need a lot of money to be an investor in mutual funds. But you will have to be disciplined to be able to earn superior returns.

Do mutual funds give guaranteed returns?

No, they don’t. Mutual fund returns are subject to market risks.

My bank fixed deposit gives me a guaranteed return. Why should I invest in mutual funds then?

The plan sounds reasonable, but sadly only in theory. A fixed deposit tends to give modest returns of 7-8.5 percent roughly. It can go up or down depending on the interest rates in the economy. On paper, this doesn’t look so bad. But there is silent killer lurking in the shadows called inflation. This is the purchasing power of your money; it is the rate at which the prices of commodities go up. Historically, inflation has been anywhere between 4-6 percent. In simple words, if your investment generates a return of 7 percent and inflation is 6 percent, then your real rate of return is just one percent point. That’s hardly any money in your hands.

I never thought about it that way….

Also, the prices of all commodities do not rise by the average inflation figure published by the government. Medical inflation is typically high and so is education inflation. Let’s see how the cost of education can go up over the years. The current cost of a two-year post-graduate diploma in management studies at the country’s premier management institution, the Indian Institute of Management-Ahmedabad (IIM), is around Rs 20 lakh. Say, you have a child who you’d think would aspire to go to an IIM after 20 years. After 20 years, the cost of this management program would be around Rs 93 lakh, if we take an inflation of 8 percent. We have taken a higher inflation because for most of us, a child’s higher education is something we wouldn’t compromise on. But to reach this figure, a modest bank fixed deposit would not be enough. Hence, you need to invest a chunk in mutual funds, especially an equity fund if your goal is so far away in future. Taxes can play added spoilsport in the overall returns from bank deposits, especially for those in the 30 percent bracket.

But my parents have been investing in insurance policies, public provident fund, and so on for years and I too invest in these instruments, by following them.

That’s the way our parents have been investing because for many years we did not have too many investment options. Apart from the Unit Scheme 64 that was launched under a special act of parliament in 1964, the first mutual fund, as we know today, was launched in the late 1980s. The first private sector mutual fund was launched in 1993. Today the size of the Indian mutual funds industry is roughly Rs 25 lakh crore, and there are 44 mutual fund houses to invest in.

The choices of products have gone up and you get schemes that cater to your long-term as well as your near-term goals. These options were not available when your parents had started investing. But today, you can make use of mutual funds and allow them to be a part of your asset allocation.

Besides, awareness has gone up over the years. Due to the options available, you can choose your investments as per your goals. For instance, if you need to buy insurance, buy a pure insurance policy. But if you need to make investments or put your savings to work for you to achieve a goal at a later date, it’s always better to invest in a pure investment vehicle such as a mutual fund, instead of insurance.

First Published on Nov 28, 2019 04:44 pm