Understanding Mutual Funds

By Mithun Girishan |

Published: February 03 2021, 14:44 GMT+0

Understanding Mutual Funds

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Have you heard the proverb ‘Don’t put all your eggs in one basket’? If you take that advice seriously, you may have a good chance in the financial markets.

Securing your financial future is not just about generating an income, it’s also about using that income wisely, otherwise you’ll keep losing the money you’ve made. The best way to use it is to invest your surplus money. While doing so, the above advice becomes very relevant. 

Look at the plight of this guy who has put all his eggs in one basket! He’s always at risk of losing all his eggs. This is exactly what happens when you put all your hard earned money in just one form of investment. 

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What’s the obvious solution here? This guy would have to distribute those eggs in different baskets to minimize the risk of losing them. The lady in the picture below has separated her eggs into different, more manageable baskets. If one basket were to fall and all the eggs in it were to break, then the woman would still have plenty of eggs in three baskets. Her losses wouldn’t be major.

Just like the example with the eggs, if you diversify your investment, then you can minimize risk and create a more secure financial future.

Making multiple investments might be the wiser way to go, but how do you choose the right investments. You need experience, knowledge, research and analysis to find the right investments. That’s where mutual funds come in handy. 

Mutual funds are a pool of money collected from various investors and managed by a professional money manager. Mutual funds are favoured by laymen who don’t want to get into the nuances of investments.  

The mutual fund’s money manager uses your investment – along with investments from other people – to invest in different portfolios like shares, bonds, or whatever is a wise investment at the time. By diversifying the investments the risk of losing is lowered. If one financial instrument doesn’t perform well, it’s compensated by other instruments which are performing better. Look at the skydivers in the image below, the first diver has one parachute, if it fails he’ll plummet to the ground unprotected. The second diver has two extra parachutes to help him land safely in case one – or two – fail.

This is how the stock holding of a mutual fund looks like.

Look at how the funds are distributed among the shares of 10 different companies. This way, you get an average of the performance of all these 10 shares. You can also see how the funds are invested in diverse financial instruments – 84.07% in equity and balance 15.93% in others. This way, the risk is minimized.

Some mutual funds strike the right balance between equity and debt. Investing in debt funds helps them earn a fixed rate of income without risk, while investing in equity funds, though a bit risky, brings in better returns.

Another question you might have is, along the lines of how much you’d require to invest. When it comes to mutual funds, there is something for everyone. You can size your investment based on your capabilities and the money you can risk. 

What you need to do is to be clear in your mind regarding what your financial goals are and then choose a scheme that matches it. Mutual funds are very flexible when it comes to making the investment. You have a variety of plans to choose from. 

If you are a businessman, you may be able to invest a lump sum. If you are a fixed income earner, then you could invest a fixed sum at regular intervals. You can invest quarterly or monthly even weekly. Investment can be as low as Rs. 500/- per month. 

The method of systematically investing is called Systematic Investment Plan (SIP). No matter how small your savings are in a month, you can still use them wisely and benefit from them. 

SIP is one of the safest, easiest and the best ways for any beginner to start investing in mutual funds. Such plans help you secure your financial future and  bring a lot of financial discipline to your life by pushing you to set aside a fixed sum every month or week.

So, what’s holding you back? Start distributing your eggs in different baskets.