Mutual Funds: What, Why and Who?

What?

Our story starts at a pizza restaurant.

Let’s say you come to this restaurant for the first time and want to try some of their pizzas. But since you are alone, your appetite and wallet allow you to order just one pizza. But that is a risk since you may end up ordering a pizza that you don’t like. That would be a waste of money.

vegetables-italian-pizza-restaurant.jpg

To avoid this and so that you get to try multiple pizzas, you call two of your friends over and the three of you order 3 pizzas and split the slices among yourselves. Now you have tasted three different pizzas without wasting any food or money. This is a simple example of a mutual fund.

The pizza restaurant is like the capital market, the pizzas are financial instruments(stocks, bonds, deposits) and the combined money(fund) pooled in by the three of you(mutually) is your mutual fund.

Definition: A mutual fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in financial securities.

 

Why?

Now that we have cleared the concept of what a Mutual Fund is, let’s have a go at why these funds are so attractive. The advantages are numerous:

  1. Save time and effort: It is very difficult to track multiple products and markets everyday to ensure good returns on your investment. By using a mutual fund scheme you transfer this task to your fund manager who is a specialist in this field
  2. Diversification: Never put all your eggs in one basket. By investing your money yourself, you are prone to restricting your investment to limited sectors/products. Instead, a mutual fund will ensure maximum diversification and thereby create minimum risk of loss.
  3. Access to more Capital: When multiple people pool in their investments through a mutual fund, they are not only distributing their risk but also creating a large capital base for the fund manager to work on. This would give him access to markets and products which an individual investor may never be able to access or afford.
  4. Easy to enter: Most MFs are very easy to invest in as they offer high liquidity and don’t have any restrictions on investment amounts. A famous campaign in India called ‘Mutual Finds Sahi Hai’ encourages people to even invest as little as INR 500 in MFs.

 

Lastly, Who?

Who is it best for? The working middle class of course!

In an earlier post in the MF Project, Rahil Jasani talks about why mutual funds are perfect for low income working class people because of the high liquidity, high returns and smaller capital outlay features.

All these characteristics perfectly fit the risk appetite of these people who are only looking to invest small amounts over time while expecting quick and meaningful returns.

By bringing them onto the MF industry, we can really create positive synergies in terms of stimulating economic activity in the Indian capital markets and at the same time enhancing the financial security of these challenged sections of the society.

The biggest challenge is of course helping these people enter the financial system by opening bank accounts(which most of them usually don’t have) and creating awareness on the power of mutual funds. The MF Project has just begun scaling this mountain of a task and the journey is bound to be truly exciting.

Stay tuned.

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