What are Mutual Funds and How Do They Work?

 

Mutual funds present a great way to invest your money and get good returns without much risk.  Instead of directly investing in stocks, you can take this route and enjoy a balanced approach. You can also invest in various instruments like stocks, bonds, and more through such funds. 

 

What is Mutual Fund Investment?

 

A mutual fund is an investment instrument that takes money from multiple investors and invests it in shares, bonds, governmental debt, gold, and other assets. When you buy a mutual fund, you receive partial ownership of all of the fund's assets. 

 

These funds are managed by professional fund managers, who handle this combination of investments. This feature makes them a good investment source if you’re a beginner.  The prospectus, meanwhile, describes the fund's assets and goals experts. A professional fund manager manages. 

 

Are Mutual Funds Traded?

 

Yes, mutual funds trade on exchanges. However, the way in which they are traded is usually different from that of stocks or direct equities. In most cases, mutual funds are traded only once a day. This is done after the market session is closed for the day.

 

💡Trading timings for the Dubai Financial Market (DFM): 10 am to 3 pm (local time)

 

The fund's performance is determined by the collective performance of its assets. The market value of the fund's shares rises in tandem with the appreciation of these assets. In contrast, if the value of the assets decreases, so does the value of the shares.

 

NAVs for Mutual Fund Returns

 

Mutual fund NAV is a key concept to understand the returns. Short for the Net Asset Value, NAV refers to the unit price at which you can buy or liquidate your mutual funds. As an investor, you are allocated units in proportion to your investments, which are computed using the NAV. 

 

In plain terms, you can think of NAV just like the price of a stock. It indicates how much each unit of your investment is worth. As your mutual fund NAV goes up or down, so does the value of your investment.

 

Benefits of Investing in Mutual Funds

 

Here are the key advantages of mutual funds — 

 

1. Portfolio Diversification: Mutual funds help you diversify your portfolio. Instead of putting all your money in one instrument, you can invest in a fund that invests in various high-yielding assets. 

2. Ease of Access: Mutual funds trade on major stock markets and are relatively easy to buy and sell, making them extremely liquid investments. 
   Furthermore, for certain asset classes, such as foreign equities or exotic assets, mutual funds are frequently the most practical — and sometimes the only — way for ordinary investors to participate.
3. Professional Management: The leading funds have expert investment managers, who are fully dedicated to growing the investment via research and strategic trading. This way, mutual funds present a low-cost solution, especially for beginners, to get a full-time supervisor to execute and supervise investments.
4. Transparency: Next on our list of the benefits of investing in mutual funds is clear access to information. Mutual funds are governed by industry laws designed to promote accountability and fairness for shareholders. Furthermore, the securities that are part of any mutual fund can be found on multiple sites. You can explore and select funds with varying management techniques and goals. 
5. Cost Averaging: Mutual funds allow you to benefit from cost averaging, also known as the practice of saving a certain amount regularly.  For instance, if you choose the SIP mode of regularly investing in mutual funds, your specified amount will be invested regardless of market fluctuations. So if the market goes down, you will actually get more units for the same amount. Over a long period, this can lead to cost-efficient investments.
6. Wide Range of Choices: You can find numerous possibilities for investing in funds to match your specific needs. For instance, if you’re looking for minimal risk, you can go for debt funds. Similarly, if you want to invest in the companies of a particular sector, you can go for sectoral funds. 

What are the Types of Mutual Funds?

 

Although many types of mutual funds are available out there, we will look at some of the most popular categories in this section — 

 

Equity (Stock) Funds

As the name suggests, these mutual funds invest in equities or stocks of different companies.  Such funds can be further categorised as per market cap, i.e. large cap, mid cap, and small mutual funds. They can also be segregated as per the investment approach — aggressive growth, income-oriented, value, and more.

 

Balanced Funds

Balanced funds, also known as asset allocation funds, aim to reduce risk through diversification. These funds invest in a variety of securities, including equities, bonds, money markets, and alternative investments. 

 

Index Mutual Funds

Index mutual funds seek to mirror the outcomes of an individual index, like the S&P 500, DJIA, Nifty 50, and more. This type of investment requires less effort from advisors, which leads to lower expenses. 

 

Bond Funds

Bond funds are part of the fixed-income category funds as they include mutual funds that generate a steady minimum return.  These funds concentrate on investments with fixed returns, primarily in the form of bonds issued by the Government or companies as well as additional debt securities. These bonds provide interest income that is distributed to shareholders while posing minimal investment risk.

 

Money Market Mutual Funds

Money market funds are similar to bond funds in that they are mostly made up of safe, risk-free debt instruments, primarily government treasury bills. However, the former mainly invests in short-term instruments. With this type, you may not get high mutual fund returns — typical returns are usually around those of conventional accounts. However, they present a good option if you want an interim storage facility for cash intended for future investments or an emergency reserve. 

 

Regional Mutual Funds

As the name suggests, these funds mainly invest in instruments that are related to a certain location, such as a nation, continent, or collection of countries with comparable economic features. These funds invest in stocks, bonds, or other assets issued by companies headquartered or generating a large portion of their revenue in a specific region.

 

Which are the Best Mutual Funds in the UAE?

 

Whether you’re looking for the best balanced mutual funds or any other category, you can check out the table to get an idea of the top options in the region and around the world —

 

*Only for reference purposes 

 

What are the Cons of Mutual Funds?

 

While mutual funds are ideal for great returns and balanced risk, they may have a few downsides — 

 

1. Risk: While diversification lowers the risk, it cannot completely eliminate the risk associated with any kind of securities in financial markets.  Although the risk is lower compared to direct equity investments, mutual fund investments are still susceptible to market risks. 
    
2. Management Fees and Exit Loads:  Mutual funds typically charge an exit load (cost) for cashing in your investments within a certain time frame, such as 12 months from the date of investment. While this is done to prevent the investor from departing the scheme too soon, it can also impact your overall mutual fund returns. 
   
   Similarly, most providers charge certain fees (expressed as mutual fund expense ratio) to manage the funds. This, too, can eat into your overall returns, especially if the fee is on the higher side. 

 

How to Invest in Mutual Funds?

 

Having understood the types of mutual funds, the next step is to understand the different ways through which you can invest in them —

 

Lump Sum

Lump sum investment means that you take a large sum of money and invest it in mutual funds all at once. So if you’ve a big chunk of money available, you can easily invest the amount altogether in a mutual fund of your choice. 

Note that the number of units that you get will depend on the mutual fund NAV on that particular day.

 

SIP

A Systematic Investment Plan (SIP) is a way of investment. It allows you to invest small amounts of money over a specific period rather than a large sum altogether. Many times, we may not be able to put large sums into funds. This problem can be easily avoided with an SIP, where you get more freedom over how much you invest and at what time. You can put in fixed amounts of money once every week, month, quarter, and so on. 

 

Another benefit of SIP investments is that you need not regularly watch the market to find the right time to invest compared to lump sum investments. This is because an SIP averages your costs, eliminating the need to monitor the market.

 

Here’s how you can make your investment in mutual funds through any well-reputed financial service provider such as a bank or a wealth management firm —

1. Visit the website and register yourself on the page to create an account.
2. Once registered, you’ll be able to find various types of funds along with extensive information. Check all these details so that you make an informed decision.
3. You can compare mutual funds as well to understand which one fits your needs and requirements the best.
4. Once you’ve chosen a mutual fund that fits your needs, fill in the required details and documents. 
5. Make the payment, and start your investment journey. 

Such platforms allow you to track the mutual fund(s) that you've invested in.

 

How to Calculate Mutual Fund Returns?

 

To find out how much your investment can grow over the years, you can always use a mutual fund calculator. With this tool, you can easily find out your returns — whether you invest lump sum or via SIP.

 

To use this calculator, you need to add a few details such as —

• Investment (whether monthly or lump sum)
• Expected mutual fund return rate
• Investment period

 

With these details, the calculator shows your total amount. This figure includes how much you’ve invested as well as the returns on the said amount.

 

Let’s understand this through the case of Salman, who wants to invest for 15 years in a mutual fund that is expected to give an annual return of 12%. He wants to invest AED 5,000 per month — for lump sum, this would turn out to be AED 900,000. 

 

Via SIP 

• Monthly investment: AED 5,000
• Tenure: 15 years
• Expected rate based on the average mutual fund return: 12%

In this case, his investment amount will be AED 900,000 and the returns will be AED 1,622,880. The total value of his mutual fund investment, thus, will be AED 2,522,880.

 

Via Lump Sum 

• One-time investment: AED 900,000
• Period: 15 years
• Expected rate: 12%

Here also his total investment amount will be AED 900,000. However, as he had put the whole amount in one go, his returns would be a whopping AED 4,026,209. This will bring the total value to AED 4,926,209.

 

Keep in mind that while the lump sum returns are significantly higher, it may not be possible for everyone to invest such a large amount once. Ultimately, the choice between lumpsum and SIP investment depends on your income, monthly expenses, and many other factors. 

 

How to Choose the Right Mutual Fund for Yourself?

 

To get the best mutual fund for yourself, you should look at certain factors —

 

• Investment goals — whether you’re looking to simply grow your money or want funds for a milestone like education, marriage, etc
• Risk tolerance — how much risk you can tolerate
  • For low tolerance — you can go for debt or hybrid funds
  • For high risk appetite — you can try out equity or growth funds 
• Investment time horizon — for shorter tenures, you can look for liquid funds
• Expense ratio — try to go for a fund with a low mutual fund expense ratio so that you don’t pay high fees for maintenance
• Past performance — note that this cannot be considered an indicator of returns ahead
• Fund manager’s profile

 

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