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Not each of us has the expertise or time to build and manage an investment portfolio. There is an excellent option available – Mutual Funds.
Mutual Fund is an investment vehicle through which people can pool their money and invest it according to a predetermined objective.
Each investor in a mutual fund gets a share of the pool in proportion to the initial investment made by him. The capital of a mutual fund is divided into shares or units and investors receive a number of units in proportion to their investment.
The investment objective of a mutual fund is always decided beforehand. Mutual funds invest multiple times in bonds, stocks, money-market instruments, real estate, commodities or other investments, or a combination of any of these.
All the details regarding the fund’s policies, objectives, charges, services etc. are available in the fund’s prospectus and every investor should read the prospectus before investing in a mutual fund.
Investment decisions for pool capital are made by a fund manager (or managers). The fund manager decides which securities are to be bought and in what quantity.
The value of the units changes with the change in the total value of the investments made by the mutual fund.
The value of each share or unit of a mutual fund is called the NAV (Net Asset Value).
Different funds have different risk-reward profiles. Mutual funds investing in stocks are a higher risk investment as compared to mutual funds investing in government bonds. Shares can go down in value resulting in losses for the investor, but money invested in bonds is safe (unless the government defaults – which is rare.) Also the higher the risk in stocks, the higher the opportunity for returns. Presents. Stocks can go up to any limit, but the returns from government bonds are limited to the interest rate offered by the government.
History of Mutual Funds:
The first “pooling of money” for investment was done in 1774. After the financial crisis of 1772–1773, Adriaan van Kettwich, a Dutch merchant, invited investors to come together to form an investment trust. The goal of the trust was to reduce the risks involved in investing by providing diversification to small investors. Funds invested in various European countries such as Austria, Denmark and Spain. Investments were primarily in bonds and a small portion of equities. The name of the trust was Indragat Makat Magat, meaning “Unity creates strength”.
The fund had several features that attracted investors:
– It had an embedded lottery.
– 4% dividend was assured, which was slightly less than the average rates prevailing at that time. Thus the interest income exceeded the required payment and the difference was converted into cash reserve.
– The cash reserve was used to retire some shares at 10% premium annually and hence the remaining shares earned higher interest. Thus the cash reserve continued to grow over time – further accelerating share redemptions.
The trust was to be dissolved at the end of 25 years and the capital was to be divided among the remaining investors.
However the war with England caused many of the bonds to default. Due to the reduction in investment income, share redemptions were suspended in 1782 and later interest payments were also reduced. The fund was no longer attractive to investors and faded away.
After being developed in Europe for some years, the idea of mutual funds reached America in the late nineteenth century. The first closed-end fund was created in the year 1893. It was named “The Boston Personal Property Trust”.
The Alexander Fund in Philadelphia was the first step toward open-end funds. It was established in 1907 and new issues came out every six months. Investors were allowed to make redemptions.
The first true open-end fund was the Massachusetts Investors Trust of Boston. Formed in 1924, it went public in 1928. 1928 also saw the rise of the first balanced fund – The Wellington Fund, which invested in both stocks and bonds.
The concept of index-based funds was introduced in 1971 by William Fouse and John McCown of Wells Fargo Bank. Based on his concept, John Bogle launched the first retail index fund in 1976. It was called the first Index Investment Trust. It is now known as the Vanguard 500 Index Fund. It crossed $100 billion in assets in November 2000 and became the world’s largest fund.
Today mutual funds have come a long way. Nearly one in two households in the US invests in mutual funds. Mutual funds are also growing in popularity in developing economies like India. They have become the preferred investment route for many investors, who value the unique combination of diversification, low cost, and simplicity provided by funds.
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