Objectives and Functions of Mutual Funds: Indian investors love mutual funds. Mutual funds are financial instruments that pool money from individuals with a common financial goal. The pooled money can be used to invest in shares, stocks of publicly traded companies, corporate or government bonds, and other investment options.
You need to be familiar with the objectives, functions and benefits of mutual funds in order to fully understand how mutual funds can help you. Keep reading for more information.
Objectives and Functions of Mutual Funds
Learn more about the goals of mutual funds
These are the goals of mutual funds.
1) Asset diversification
The reason mutual funds are so great investments is because they have many assets. Expert investors often advise against putting all your eggs in the same basket.
Doing so will increase the risk that your portfolio will suffer from a decline in asset values. Because mutual funds hold a wide range of assets, they provide diversification that protects your investment against a loss in any one of them.
2) Generating income
Fixed-income investment managers typically use two types investment management styles to generate income. They are spread traders or interest rate anticipateors. It is more risky to invest in mutual funds if it has income generation as its primary objective. Its returns, however, are high.
A mutual fund that has a high potential for income should be a dividend and mortgage fund, as well as domestic and international bond funds.
3) Capital protection
Mutual funds are a great way to protect your capital. These mutual funds usually have a lower rate of return. Money market mutual funds are a good example of this type of mutual fund.
4) Initiating growth
For inflation protection, mutual funds that primarily focus on growth are an excellent investment option. These funds are often called equity funds. They may have shares in common stocks or preferred shares.
These mutual funds offer higher returns than traditional income funds, but also have higher risk.
Common functions of mutual funds
You need to understand how mutual funds work in order to fully appreciate their function. Here’s how it works.
1) NFO release
A New Fund Offer (NFO), is a launch that allows a company to start a mutual funds. Its fund manager creates and shares the strategy prior to the launch. Investors then can decide how much they wish to invest. As an NFO is brand new, investing in it will be less expensive than existing funds.
If you’re considering investing in an NFO release please verify the minimum subscription, investment cost, objectives, reputation of fund houses, and reputation of the fund.
2) Pooling money
After the NFO, mutual fund companies receive funds from interested investors to purchase shares in a variety stocks, bonds, and other investments. Investors have the ability to buy shares of mutual funds at their convenience.
3) Investments in securities
The strategy of the mutual fund determines how the fund manager will invest the funds.
Mutual funds are safer than stocks and other investments. This is because the dedicated manager of the mutual fund does extensive research on the economy, industry, and company before making any investment decision.
The fund manager can use this information to find the most suitable securities and maximize the return for their investors.
4) Return of funds
As mutual funds generate returns, the funds can be distributed among investors or reinvested in the fund’s holdings.
You will receive dividends if you choose a dividend-fund fund. To increase wealth, the manager of growth funds will reinvest the dividends into the fund.
So you can conclude that mutual funds ‘s functions include maximising investor wealth, and channelising it.
Hypothetical example of how mutual fund work
Let’s use an example to better understand the process.
Let’s say that Reliance launches a mutual funds scheme called RIL Top 30 Fund. The company has 100 investors, and the pool is able to invest Rs.1 crore. Every investor contributes Rs.1 million to the mutual funds.
Every investor gets 10,000 units if the Net Asset Value (NAV) is Rs.10. Thus, 10 lakh units have been issued.
Fund managers will then use these funds to choose the top 30 mutual funds that best match their strategy and give the best returns for investors. The fund manager then chooses the top 30 stocks based on market analysis. After that, he divides the funds equally among all stocks.
This means that the equity fund consists of the top 30 mutual funds. The Assets Under Management of this mutual fund is Rs.1 Crore
Let’s suppose that there is no change in the portfolio of mutual funds with respect to holdings and investors. If the stock price rises, the portfolio value will increase, leading to a profit.
Investors also have the option of selling their investments or reinvesting them. The fund manager will use the cash balance of the fund portfolio to pay off the investor. He may also choose to sell shares of the mutual fund’s portfolio. The shares in this case will only be those of companies that have no growth potential.
Let’s now assume that stock prices decline. In such a scenario, the NAV also falls. But, if another investor joins the mutual funds, and invests the same amount, the situation will change.
The unit count for this new investor will be lower, which you can consider ‘x”. Portfolio value will increase because of his/her investment. Additionally, the total number will rise by ‘x units.
This is a basic explanation of how mutual funds work. Daily mutual fund life cycles include redemptions and investments. Also, the NAV changes daily. The entire process revolves around the concept.
Once you are familiar with mutual funds, it is time to dive deeper into the world of mutual funds. You can make your wealth grow by selecting the right mutual funds.