Mutual fund

From Wikipedia, the free encyclopedia

This article is about mutual funds in the United States. For other forms of mutual investment, see Collective investment scheme.

The examples and perspective in this article deal primarily with the United States and do not represent a worldwide view of the subject. Please improve this article and discuss the issue on the talk page. (September 2011)
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks,bonds, short-term money market instruments, and/or other securities.[1]
Contents
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1 Overview

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1.1 Advantages of mutual funds 1.2 Disadvantages of mutual funds

2 History 3 Leading mutual fund complexes 4 Types of mutual funds

o o o o

4.1 Open-end funds 4.2 Closed-end funds 4.3 Unit investment trusts 4.4 Exchange-traded funds

5 Investments and classification

o o o o o

5.1 Money market funds 5.2 Bond funds 5.3 Stock or equity funds 5.4 Hybrid funds 5.5 Index (passively-managed) versus actively-managed

6 Mutual fund expenses

6.1 Distribution charges

6.1.1 Front-end load or sales charge 6.1.2 Back-end load 6.1.3 12b-1 fees 6.1.4 No-load funds 6.1.5 Share classes

6.2 Management fee

o o o o o

6.3 Other fund expenses 6.4 Shareholder transaction fees 6.5 Securities transaction fees 6.6 Expense ratio 6.7 Controversy

7 Definitions

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7.1 Net asset value or NAV 7.2 Average annual total return 7.3 Turnover

8 Criticisms

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8.1 Source of market volatility 8.2 Mutual-fund scandal

9 See also 10 References

[edit]Overview
In the United States, a mutual fund is registered with the Securities and Exchange Commission (SEC) and is overseen by a board of directors (if organized as a corporation) or board of trustees (if organized as a trust). The board is charged with ensuring that the fund is managed in the best interests of the fund's investors and with hiring the fund manager and other service providers to the fund. The fund manager, also known as the fund sponsor or fund management company, trades (buys and sells) the fund's investments in accordance with the fund's investment objective. A fund manager must be a registered investment advisor. Funds that are managed by the same fund manager and that have the same brand name are known as a "fund family" or "fund complex". The Investment Company Act of 1940 (the 1940 Act) established three types of registered investment companies or RICs in the United States: open-end funds, unit investment trusts (UITs); and closed-end funds. Recently, exchange-traded funds (ETFs), which are open-end funds or unit investment trusts that trade on an exchange, have gained in popularity. While the term "mutual fund" may refer to all three types of registered investment companies, it is more commonly used to refer exclusively to the open-end type. Hedge funds are not considered a type of mutual fund. While they are another type of commingled investment scheme, they are not governed by the Investment Company Act of 1940 and are not required to register with the Securities and Exchange Commission (though many hedge fund managers now must register as investment advisors). Mutual funds are not taxed on their income as long as they comply with certain requirements established in the Internal Revenue Code. Specifically, they must diversify their investments, limit ownership of voting securities, distribute most of their income to their investors annually, and earn most of the income by

investing in securities and currencies.[2] Mutual funds pass taxable income on to their investors. The type of income they earn is unchanged as it passes through to the shareholders. For example, mutual fund distributions of dividend income are reported as dividend income by the investor. There is an exception: net losses incurred by a mutual fund are not distributed or passed through to fund investors. Outside of the United States, mutual fund is used as a generic term for various types of collective investment vehicles available to the general public, such as unit trusts, open-ended investment companies, unitized insurance funds, Undertakings for Collective Investment in Transferable Securities, and SICAVs.

[edit]Advantages

of mutual funds

Mutual funds have advantages compared to direct investing in individual securities.[3] These include:

Increased diversification Daily liquidity Professional investment management Ability to participate in investments that may be available only to larger investors Service and convenience Government oversight Ease of comparison

[edit]Disadvantages

of mutual funds

Mutual funds have disadvantages as well, which include[4]:

Fees Less control over timing of recognition of gains Less predictable income No opportunity to customize

[edit]History
The first mutual funds were established in Europe. One researcher credits a Dutch merchant with creating the first mutual fund in 1774.[5] The first mutual fund outside the Netherlands was the Foreign & Colonial Government Trust, which was established in London in 1868. It is now the Foreign & Colonial Investment Trust and trades on the London stock exchange.[6] Mutual funds were introduced into the United States in the 1890s.[7] They became popular during the 1920s. These early funds were generally of the closed-end type with a fixed number of shares which often traded at prices above the value of the portfolio.[8] The first open-end mutual fund with redeemable shares was established on March 21, 1924. This fund, the Massachusetts Investors Trust, is now part of the MFS family of funds. However, closed-end funds

remained more popular than open-end funds throughout the 1920s. By 1929, open-end funds accounted for only 5% of the industry's $27 billion in total assets.[9] After the stock market crash of 1929, Congress passed a series of acts regulating the securities markets in general and mutual funds in particular. The Securities Act of 1933 requires that all investments sold to the public, including mutual funds, be registered with the Securities and Exchange Commission and that they provide prospective investors with a prospectus that discloses essential facts about the investment. The Securities and Exchange Act of 1934 requires that issuers of securities, including mutual funds, report regularly to their investors; this act also created the Securities and Exchange Commission, which is the principal regulator of mutual funds. The Revenue Act of 1936established guidelines for the taxation of mutual funds, while the Investment Company Act of 1940 governs their structure. When confidence in the stock market returned in the 1950s, the mutual fund industry began to grow again. By 1970, there were approximately 360 funds with $48 billion in assets.[10] The introduction of money market funds in the high interest rate environment of the late 1970s boosted industry growth dramatically. The first retail index fund, First Index Investment Trust, was formed in 1976 by The Vanguard Group, headed by John Bogle; it is now called the Vanguard 500 Index Fund and is one of the world's largest mutual funds, with more than $100 billion in assets as of January 31, 2011.[11] Fund industry growth continued into the 1980s and 1990s, as a result of three factors: a bull market for both stocks and bonds, new product introductions (including tax-exempt bond, sector, international and target date funds) and wider distribution of fund shares.[12] Among the new distribution channels were retirement plans. Mutual funds are now the preferred investment option in certain types of fast-growing retirement plans, specifically in 401(k) and other defined contribution plans and in individual retirement accounts (IRAs), all of which surged in popularity in the 1980s. Total mutual fund assets fell in 2008 as a result of the credit crisis of 2008. At the end of 2010, there were 7,581 mutual funds in the United States with combined assets of $11.8 trillion, according to the Investment Company Institute (ICI), a national trade association of investment companies in the United States. The ICI reports that worldwide mutual fund assets were $24.7 trillion on the same date.[13]

[edit]Leading

mutual fund complexes

At the end of 2009, the top 10 mutual fund complexes in the United States were:[14] 1. Fidelity Investments 2. Vanguard Group 3. Capital Research & Management (American Funds) 4. JP Morgan Chase & Co. 5. BlackRock Funds 6. PIMCO Funds

7. Franklin Templeton Investments 8. Federated Investors 9. Bank of New York Mellon 10. Goldman Sachs & Co.

[edit]Types

of mutual funds

There are three basic types of registered investment companies defined in the Investment Company Act of 1940: open-end funds, unit investment trusts, and closed-end funds. Exchange-traded funds are open-end funds or unit investment trusts that trade on an exchange.

[edit]Open-end

funds

Open-end mutual funds must be willing to buy back their shares from their investors at the end of every business day at the net asset value computed that day. Most open-end funds also sell shares to the public every business day; these shares are also priced at net asset value. A professional investment manager oversees the portfolio, buying and selling securities as appropriate. The total investment in the fund will vary based on share purchases, share redemptions and fluctuation in market valuation. There is no legal limit on the number of shares that can be issued.

[edit]Closed-end

funds

Closed-end funds generally issue shares to the public only once, when they are created through an initial public offering. Their shares are then listed for trading on a stock exchange. Investors who no longer wish to invest in the fund cannot sell their shares back to the fund (as they can with an open-end fund). Instead, they must sell their shares to another investor in the market; the price they receive may be significantly different from net asset value. It may be at a "premium" to net asset value (meaning that it is higher than net asset value) or, more commonly, at a "discount" to net asset value (meaning that it is lower than net asset value). A professional investment manager oversees the portfolio, buying and selling securities as appropriate.

[edit]Unit

investment trusts

Unit investment trusts or UITs issue shares to the public only once, when they are created. Investors can redeem shares directly with the fund (as with an open-end fund) or they may also be able to sell their shares in the market. Unit investment trusts do not have a professional investment manager. Their portfolio of securities is established at the creation of the UIT and does not change. UITs generally have a limited life span, established at creation.

[edit]Exchange-traded

funds

Main article: Exchange-traded fund A relatively recent innovation, the exchange-traded fund or ETF is often structured as an open-end investment company, though ETFs may also be structured as unit investment trusts, partnerships, investments trust, grantor trusts or bonds (as an exchange-traded note). ETFs combine characteristics of

both closed-end funds and open-end funds. Like closed-end funds, ETFs are traded throughout the day on a stock exchange at a price determined by the market. However, as with open-end funds, investors normally receive a price that is close to net asset value. To keep the market price close to net asset value, ETFs issue and redeem large blocks of their shares with institutional investors. Most ETFs are index funds.

[edit]Investments

and classification

Mutual funds may invest in many kinds of securities. The types of securities that a particular fund may invest in are set forth in the fund's prospectus, which describes the fund's investment objective, investment approach and permitted investments. The investment objective describes the type of income that the fund seeks. For example, a "capital appreciation" fund generally looks to earn most of its returns from increases in the prices of the securities it holds, rather than from dividend or interest income. The investment approach describes the criteria that the fund manager uses to select investments for the fund. A mutual fund's investment portfolio is continually monitored by the fund's portfolio manager or managers, who are employed by the fund's manager or sponsor. Mutual funds are classified by their principal investments. The four largest categories of funds are money market funds, bond or fixed income funds, stock or equity funds and hybrid funds. Within these categories, funds may be subclassified by investment objective, investment approach or specific focus. The SEC requires that mutual fund names not be inconsistent with a fund's investments. For example, the "ABC New Jersey Tax-Exempt Bond Fund" would generally have to invest, under normal circumstances, at least 80% of its assets in bonds that are exempt from federal income tax, from the alternative minimum tax and from taxes in the state of New Jersey.[15] Bond, stock and hybrid funds may be classified as either index (passively-managed) funds or activelymanaged funds.

[edit]Money

market funds

Money market funds invest in money market instruments, which are fixed income securities with a very short time to maturity and high credit quality. Investors often use money market funds as a substitute for bank savings accounts, though money market funds are not government insured, unlike bank savings accounts. Money market funds strive to maintain a $1.00 per share net asset value, meaning that investors earn interest income from the fund but do not experience capital gains or losses. If a fund fails to maintain that $1.00 per share because its securities have declined in value, it is said to "break the buck". Only two money market funds have ever broken the buck: Community Banker's U.S. Government Money Market Fund in 1994 and the Reserve Primary Fund in 2008. At the end of 2010, money market funds accounted for 24% of the assets in all U.S. mutual funds. [13]

[edit]Bond

funds

Bond funds invest in fixed income securities. Bond funds can be subclassified according to the specific types of bonds owned (such as high-yield or junk bonds, investment-grade corporate bonds, government bonds or municipal bonds) or by the maturity of the bonds held (short-, intermediate- or long-term). Bond funds may invest in primarily U.S. securities (domestic or U.S. funds), in both U.S. and foreign securities (global or world funds), or primarily foreign securities (international funds). At the end of 2010, bond funds accounted for 22% of the assets in all U.S. mutual funds.[13]

[edit]Stock

or equity funds

Stock or equity funds invest in common stocks. Stock funds may invest in primarily U.S. securities (domestic or U.S. funds), in both U.S. and foreign securities (global or world funds), or primarily foreign securities (international funds). They may focus on a specific industry or sector. A stock fund may be subclassified along two dimensions: (1) market capitalization and (2) investment style (i.e., growth vs. blend/core vs. value). The two dimensions are often displayed in a grid known as a "style box." Market capitalization or market cap is the value of a company's stock and equals the number of shares outstanding times the market price of the stock. Market capitalizations are divided into the following categories:

Micro cap Small cap Mid cap Large cap

While the specific definitions of each category vary with market conditions, large cap stocks generally have market capitalizations of at least $10 billion, small cap stocks have market capitalizations below $2 billion, and micro cap stocks have market capitalizations below $300 million. Funds are also classified in these categories based on the market caps of the stocks that it holds. Stock funds are also subclassified according to their investment style: growth, value or blend (or core). Growth funds seek to invest in stocks of fast-growing companies. Value funds seek to invest in stocks that appear cheaply priced. Blend funds are not biased toward either growth or value. At the end of 2010, stock funds accounted for 48% of the assets in all U.S. mutual funds.[13]

[edit]Hybrid

funds

Hybrid funds invest in both bonds and stocks or in convertible securities. Balanced funds, asset allocation funds, target date or target risk funds and lifecycle or lifestyle funds are all types of hybrid funds. Hybrid funds may be structured as funds of funds, meaning that they invest by buying shares in other mutual funds that invest in securities. Most fund of funds invest in affiliated funds (meaning mutual funds

managed by the same fund sponsor), although some invest in unaffiliated funds (meaning those managed by other fund sponsors) or in a combination of the two. At the end of 2010, hybrid funds accounted for 6% of the assets in all U.S. mutual funds.[13]

[edit]Index

(passively-managed) versus actively-managed

Main articles: Index fund and active management An index fund or passively-managed fund seeks to match the performance of a market index, such as the S&P 500 index, while an actively managed fund seeks to outperform a relevant index through superior security selection.

[edit]Mutual

fund expenses

Investors in mutual funds pay fees. These fall into four categories: distribution charges (sales loads and 12b-1 fees), the management fee, other fund expenses, shareholder transaction fees and securities transaction fees. Some of these expenses reduce the value of an investor's account; others are paid by the fund and reduce net asset value. Recurring expenses are included in a fund's expense ratio.

[edit]Distribution

charges

Main article: Mutual fund fees and expenses Distribution charges pay for marketing and distribution of the fund's shares to investors.

[edit]Front-end load or sales charge

A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares are purchased. It is expressed as a percentage of the total amount invested (including the front-end load), known as the "public offering price." The front-end load often declines as the amount invested increases, through breakpoints. Front-end loads are deducted from an investor's account and reduce the amount invested.

[edit]Back-end load
Some funds have a back-end load, which is paid by the investor when shares are redeemed depending on how long they are held. The back-end loads may decline the longer the investor holds shares. Back-end loads with this structure are called contingent deferred sales charges (or CDSCs). Like front-end loads, back-end loads are deducted from an investor's account.

[edit]12b-1 fees
A mutual fund may charge an annual fee, known as a 12b-1 fee, for marketing and distribution services. This fee is computed as a percentage of a fund's assets, subject to a maximum of 1% of assets. The 12b-1 fee is included in the expense ratio.

[edit]No-load funds

A no-load fund does not charge a front-end load under any circumstances, does not charge a back-end load under any circumstances and does not charge a 12b-1 fee greater than 0.25% of fund assets.

[edit]Share classes
A single mutual fund may give investors a choice of different combinations of front-end loads, back-end loads and 12b-1 fees, by offering several different types of shares, known as share classes. All of the shares classes invest in the same portfolio of securities, but each has different expenses and, therefore, a different net asset value and different performance results. Some of these share classes may be available only to certain types of investors. Typical share classes for funds sold through brokers or other intermediaries are:

Class A shares usually charge a front-end sales load together with a small 12b-1 fee. Class B shares don't have a front-end sales load. Instead they, have a high contingent deferred sales charge, or CDSC that declines gradually over several years, combined with a high 12b-1 fee. Class B shares usually convert automatically to Class A shares after they have been held for a certain period.

Class C shares have a high 12b-1 fee and a modest contingent deferred sales charge that is discontinued after one or two years. Class C shares usually do not convert to another class. They are often called "level load" shares.

Class I are subject to very high minimum investment requirements and are, therefore, known as "institutional" shares. They are no-load shares.

Class R are for use in retirement plans such as 401(k) plans. They do not charge loads, but do charge a small 12b-1 fee.

No-load funds often have two classes of shares:

Class I shares do not charge a 12b-1 fee. Class N shares charge a 12b-1 fee of no more than 0.25% of fund assets.

Neither class of shares charges a front-end or back-end load.

[edit]Management

fee

The management fee is paid to the fund manager or sponsor who organizes the fund, provides the portfolio management or investment advisory services and normally lends its brand name to the fund. The fund manager may also provide other administrative services. The management fee often has breakpoints, which means that it declines as assets (in either the specific fund or in the fund family as a whole) increase. The management fee is paid by the fund and is included in the expense ratio.

[edit]Other

fund expenses

A mutual fund pays for other services including:

Board of directors' (or board of trustees') fees and expenses

Custody fee: paid to a bank for holding the fund's portfolio in safekeeping Fund accounting fee: for computing the net asset value daily Professional services fees: legal and accounting fees Registration fees: when making filings with regulatory agencies Shareholder communications expenses: printing and mailing required documents to shareholders Transfer agent services fee: keeping shareholder records and responding to customer inquiries

These expenses are included in the expense ratio.

[edit]Shareholder

transaction fees

Shareholders may be required to pay fees for certain transactions. For example, a fund may charge a flat fee for maintaining an individual retirement account for an investor. Some funds charge redemption fees when an investor sells fund shares shortly after buying them (usually defined as within 30, 60 or 90 days of purchase); redemption fees are computed as a percentage of the sale amount. Shareholder transaction fees are not part of the expense ratio.

[edit]Securities

transaction fees

A mutual fund pays any expenses related to buying or selling the securities in its portfolio. These expenses may include brokerage commissions. Securities transaction fees increase the cost basis of the investments. They do not flow through the income statement and are not included in the expense ratio. The amount of securities transaction fees paid by a fund is normally positively correlated with its trading volume or "turnover".

[edit]Expense

ratio

The expense ratio allows investors to compare expenses across funds. The expense ratio equals the 12b-1 fee plus the management fee plus the other fund expenses divided by average net assets. The expense ratio is sometimes referred to as the "total expense ratio" or TER.

[edit]Controversy
Critics of the fund industry argue that fund expenses are too high. They believe that the market for mutual funds is not competitive and that there are many hidden fees, so that it is difficult for investors to reduce the fees that they pay. Many researchers have suggested that the most effective way for investors to raise the returns they earn from mutual funds is to reduce the fees that they pay. They suggest that investors look for no-load funds with low expense ratios.

[edit]Definitions
Definitions of key terms.

[edit]Net

asset value or NAV

Main article: Net asset value

A fund's net asset value or NAV equals the current market value of a fund's holdings minus the fund's liabilities (sometimes referred to as "net assets"). It is usually expressed as a per-share amount, computed by dividing by the number of fund shares outstanding. Funds must compute their net asset value every day the New York Stock Exchange is open. Valuing the securities held in a fund's portfolio is often the most difficult part of calculating net asset value. The fund's board of directors (or board of trustees) oversees security valuation.

[edit]Average

annual total return

The SEC requires that mutual funds report the average annual compounded rates of return for 1-year, 5year and 10-year periods using the following formula:[16] P(1+T)n = ERV Where: P = a hypothetical initial payment of $1,000. T = average annual total return. n = number of years. ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion).

[edit]Turnover
Turnover is a measure of the volume of a fund's securities trading. It is expressed as a percentage of net asset value and is normally annualized. Turnover equals the lesser of a fund's purchases or sales during a given period (of no more than a year) divided by average net assets. If the period is less than a year, the turnover figure is annualized.

[edit]Criticisms
The most widespread criticism of mutual funds is that they tend to have a poorer return on investment than even simple index funds[17] In fact, only 17% of mutual funds beat indexes, only 5% beating them by more than 1% return on investment. In fact, Morningstar, Inc reports that if mutual fund managers had, in 2000, simply held their existing assets instead of continuing to buy and sell, performance would have increased an average of 1.6% every single year for the next decade. Likewise, investors are 7 times as likely to lose money, adding up to an overall 85% likelyhood of losing, in the long run. This is not only because the micromanagement of a mutual fund tends to do more harm than good, versus an index, but also because of the significant fees that mutual funds charge. Such fees are understated by Federally-mandated "weighting" of "average" fees.

Without this weighting, they actually turn out to be over 60% higher than their official numbers[18]. Additionally, mutual fund managers and dealers suffer conflict of interest accusations, akin to other parts of the modern securities industry. They are seen as pushing not those that are good for the investor, but those that benefit the managers, themselves, which is often almost the opposite[19]

[edit]Source

of market volatility

Another concern about mutual funds is their sizable contribution to, or even existence as the source of, market volatility[20][21]. As mutual funds have come to dominate investment because of various government mandates like the 401K that encourage their use, the tendency of fund managers to buy high and sell low, in order to make internal profits that are never seen by the investor, have become an area of concern for critics[22].

[edit]Mutual-fund

scandal

Main article: Mutual-fund scandal (2003) In September 2003, the United States mutual fund industry was beset by a scandal in which several major fund companies permitted and facilitated late trading, akin to the futures trading scandals of the mid to late 1990s. Federal regulations ban the sale of mutual fund shares after 4PM EST, at the closing price. On September 3, 2003, New York's Attorney General announced the issuance of a complaint against a New Jersey hedge fund company , charging that they had engaged in "late trading" in collusion with Bank of America, who was charged with permitting the company to purchase mutual fund shares, after the markets had closed, at the closing price for that day. Spitzer's investigation was initiated after his office received a tenminute June 2003 phone call from aWall Street worker alerting them to an instance of the late trading problem. This was followed by a flurry of other accusations and investigations, both by New York and the SEC, most of which were "settled", but with some involving counter-charges of Attorney General Elliot Spitzer overstepping his authority, and one case lost in court.

[edit]See

also

Fund derivative Global assets under management Institutional investor Investment management

Lipper average List of mutual fund companies in Canada List of mutual-fund families in the United States List of US mutual funds by assets under management Mutual funds in India Money fund Mutual-fund scandal (2003) Pension Retirement plans in the United States Separately managed account or SMAs Socially responsible investing Superannuation fund Value investing Venture capital

Basics of mutual funds

The article mentioned below, is for the investors who have not yet started investing in mutual funds, but willing to explore the opportunity and also for those who want to clear their basics for what is mutual fund and how best it can serve as an investment tool.

Getting Started
Before we move to explain what is mutual fund, its very important to know the area in which mutual funds works, the basic understanding of stocks and bonds.

Stocks
Stocks represent shares of ownership in a public company. Examples of public companies include Reliance, ONGC and Infosys. Stocks are considered to be the most common owned

investment traded on the market.

Bonds
Bonds are basically the money which you lend to the government or a company, and in return you can receive interest on your invested amount, which is back over predetermined amounts of time. Bonds are considered to be the most common lending investment traded on the market. There are many other types of investments other than stocks and bonds (including annuities, real estate, and precious metals), but the majority of mutual funds invest in stocks and/or bonds. TOP

Working of Mutual Fund

TOP

Regulatory Authorities
To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds. It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to time. MF either promoted by public or by private sector entities including one promoted by foreign entities is governed by these Regulations. SEBI approved Asset Management Company (AMC) manages the funds by making investments in various types of securities. Custodian, registered with SEBI, holds the securities of various schemes of the fund in its custody. According to SEBI Regulations, two thirds of the directors of Trustee Company or board of trustees must be independent. The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual funds that the mutual funds function within the strict regulatory framework. Its objective is to increase public awareness of the mutual fund industry.

AMFI also is engaged in upgrading professional standards and in promoting best industry practices in diverse areas such as valuation, disclosure, transparency etc. TOP

What is a Mutual Fund?

A mutual fund is just the connecting bridge or a financial intermediary that allows a group of investors to pool their money together with a predetermined investment objective. The mutual fund will have a fund manager who is responsible for investing the gathered money into specific securities (stocks or bonds). When you invest in a mutual fund, you are buying units or portions of the mutual fund and thus on investing becomes a shareholder or unit holder of the fund. Mutual funds are considered as one of the best available investments as compare to others they are very cost efficient and also easy to invest in, thus by pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. But the biggest advantage to mutual funds is diversification, by minimizing risk & maximizing returns. TOP

Diversification
Diversification is nothing but spreading out your money across available or different types of investments. By choosing to diversify respective investment holdings reduces risk tremendously up to certain extent. The most basic level of diversification is to buy multiple stocks rather than just one stock. Mutual funds are set up to buy many stocks. Beyond that, you can diversify even more by purchasing different kinds of stocks, then adding bonds, then international, and so on. It could take you weeks to buy all these investments, but if you purchased a few mutual funds you could be done in a few hours because mutual funds automatically diversify in a predetermined category of investments (i.e. - growth companies, emerging or mid size companies, low-grade corporate bonds, etc). TOP

Types of Mutual Funds Schemes in India

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risk tolerance and return expectations etc. thus mutual funds has Variety of flavors, Being a collection of many stocks, an investors can go for picking a mutual fund might be easy. There are over hundreds of mutual funds scheme to choose from. It is easier to think of mutual funds in categories, mentioned below.

Overview of existing schemes existed in mutual fund category: BY STRUCTURE

1. Open - Ended Schemes: An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value

("NAV") related prices. The key feature of open-end schemes is liquidity. 2. Close - Ended Schemes: These schemes have a pre-specified maturity period. One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation, expectations of unitholder and other market factors. Alternatively some close-ended schemes provide an additional option of selling the units directly to the Mutual Fund through periodic repurchase at the schemes NAV; however one cannot buy units and can only sell units during the liquidity window. SEBI Regulations ensure that at least one of the two exit routes is provided to the investor. 3. Interval Schemes: Interval Schemes are that scheme, which combines the features of open-ended and closeended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.

The risk return trade-off indicates that if investor is willing to take higher risk then correspondingly he can expect higher returns and vise versa if he pertains to lower risk instruments, which would be satisfied by lower returns. For example, if an investors opt for bank FD, which provide moderate return with minimal risk. But as he moves ahead to invest in capital protected funds and the profit-bonds that give out more return which is slightly higher as compared to the bank deposits but the risk involved also increases in the same proportion. Thus investors choose mutual funds as their primary means of investing, as Mutual funds

provide professional management, diversification, convenience and liquidity. That doesnt mean mutual fund investments risk free. This is because the money that is pooled in are not invested only in debts funds which are less riskier but are also invested in the stock markets which involves a higher risk but can expect higher returns. Hedge fund involves a very high risk since it is mostly traded in the derivatives market which is considered very volatile.

Overview of existing schemes existed in mutual fund category: BY NATURE

1. Equity fund: These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund managers outlook on different stocks. The Equity Funds are sub-classified depending upon their investment objective, as follows:

Diversified Equity Funds Mid-Cap Funds Sector Specific Funds Tax Savings Funds (ELSS)

Equity investments are meant for a longer time horizon, thus Equity funds rank high on the risk-return matrix. 2. Debt funds: The objective of these Funds is to invest in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:

Gilt Funds: Invest their corpus in securities issued by Government, popularly known as Government of India debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government.

Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities.

MIPs: Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes.

Short Term Plans (STPs): Meant for investment horizon for three to six months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures.

Liquid Funds: Also known as Money Market Schemes, These funds provides easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds.

3. Balanced funds: As the name suggest they, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns. Further the mutual funds can be broadly classified on the basis of investment parameter viz, Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. The investor can align his own investment needs with the funds objective and invest accordingly.

By investment objective:
Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over medium to long term. These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation.

Income Schemes:Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited.

Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes invest in both shares and fixed income securities, in the proportion indicated in their offer documents (normally 50:50).

Money Market Schemes: Money Market Schemes aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter-bank call money.

Other schemes
Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.

Index Schemes: Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weightage. And hence, the returns from such schemes would be more or less equivalent to those of the Index.

Sector Specific Schemes: These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. TOP

Types of returns
There are three ways, where the total returns provided by mutual funds can be enjoyed by investors:

Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all income it receives over the year to fund owners in the form of a distribution.

If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.

If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price. You can then sell your mutual fund shares for a profit. Funds will also usually give you a choice either to receive a check for distributions or to reinvest the earnings and get more shares. TOP

Pros & cons of investing in mutual funds:

For investments in mutual fund, one must keep in mind about the Pros and cons of investments in mutual fund. Advantages of Investing Mutual Funds: 1. Professional Management - The basic advantage of funds is that, they are professional managed, by well qualified professional. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is considered to be relatively less expensive way to make and monitor their investments. 2. Diversification - Purchasing units in a mutual fund instead of buying individual stocks or

bonds, the investors risk is spread out and minimized up to certain extent. The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others. 3. Economies of Scale - Mutual fund buy and sell large amounts of securities at a time, thus help to reducing transaction costs, and help to bring down the average cost of the unit for their investors. 4. Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate their holdings as and when they want.

5. Simplicity - Investments in mutual fund is considered to be easy, compare to other available instruments in the market, and the minimum investment is small. Most AMC also have automatic purchase plans whereby as little as Rs. 2000, where SIP start with just Rs.50 per month basis.

Disadvantages of Investing Mutual Funds: 1. Professional Management- Some funds doesnt perform in neither the market, as their management is not dynamic enough to explore the available opportunity in the market, thus many investors debate over whether or not the so-called professionals are any better than mutual fund or investor him self, for picking up stocks. 2. Costs The biggest source of AMC income, is generally from the entry & exit load which they charge from an investors, at the time of purchase. The mutual fund industries are thus charging extra cost under layers of jargon. 3. Dilution - Because funds have small holdings across different companies, high returns from a few investments often don't make much difference on the overall return. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money. 4. Taxes - when making decisions about your money, fund managers don't consider your personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is triggered, which affects how profitable the individual is from the sale. It might have been more advantageous for the individual to defer the capital gains liability. TOP

Mutual Funds: Introduction

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As you probably know, mutual funds have become extremely popular over the last 20 years. What was once just another obscure financial instrument is now a part of our daily lives. More than 80 million people, or one half of the households in America, invest in mutual funds. That means that, in the United States alone, trillions of dollars are invested in mutual funds. (For more reading, see A Brief History Of The Mutual Fund.) In fact, to many people, investing means buying mutual funds. After all, it's common knowledge that investing in mutual funds is (or at least should be) better than simply letting your cash waste away in a savings account, but, for most people, that's where the understanding of funds ends. It doesn't help that mutual fund salespeople speak a strange language that is interspersed with jargon that many investors don't understand. Originally, mutual funds were heralded as a way for the little guy to get a piece of the market. Instead of spending all your free time buried in the financial pages of the Wall Street Journal, all you had to do was buy a mutual fund and you'd be set on your way to financial freedom. As you might have guessed, it's not that easy. Mutual funds are an excellent idea in theory, but, in reality, they haven't always delivered. Not all mutual funds are created equal, and investing in mutuals isn't as easy as throwing your money at the first salesperson who solicits your business. (Learn about the pros and cons in Mutual Funds Are Awesome - Except When They're Not.) In this tutorial, we'll explain the basics of mutual funds and hopefully clear up some of the myths around them. You can then decide whether or not they are right for you.

Next: Mutual Funds: What Are They?

Table of Contents 1) Mutual Funds: Introduction 2) Mutual Funds: What Are They? 3) Mutual Funds: Different Types Of Funds 4) Mutual Funds: The Costs 5) Mutual Funds: Picking A Mutual Fund 6) Mutual Funds: How To Read A Mutual Fund Table 7) Mutual Funds: Evaluating Performance 8) Mutual Funds: Conclusion

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