1. What are Mutual Funds?
Suppose Ali and Ahmad live in the same neighborhood. Here are their personal circumstances:
- Ali has savings of Rs. 3500 and wants to invest. He works as a consultant and thus, his income is quite variable. Ali’s top priority is to keep getting regular or steady income in the future.
- Ahmad has Rs. 1500 and is looking for investment opportunities. He is worried that the amount may be too small for investment. He also wants to enjoy a decent but regular source of income.
Considering the above-mentioned circumstances of Ali and Ahmad, they decide to go to a firm called Money X. This firm is known for making customized investment plans for people in this neighborhood. Money X recommends Ali and Ahmad to combine their funds so that it has more buying power. While Rs. 1500 is a small amount, the combined amount of Rs. 5000 is sufficient to buy a variety of low-risk securities . In this case, Money X collects money from Ali, Ahmad and 5 other people from the neighborhood. All investors have a mutual goal of earning steady income in the future. Money X formulates a ‘Fund P’ that uses this ‘pooled’ money and invests it in various government-issued securities and bank deposits. Money X ensures that these securities aren’t risky and that they provide steady income to the fundholders. Thus
Mutual Fund is an investment vehicle that pools money from various investors and utilize those funds in purchasing a basket of securities including stocks, bonds, commodities, cash, savings accounts and even other mutual funds.
You must be wondering why Ali and Ahmad didn’t buy the government-issued securities or put their money in savings account themselves? Here are some of the reasons to invest into Mutual Funds in Pakistan:
- Mutual Funds rely on pooling money from a variety of investors. Therefore, small investors are able to invest in portfolios that they wouldn’t be able to afford on their own. For example, Ali’s savings of Rs. 3500 aren’t enough to invest in 4 different government-backed securities and a savings account. However, through Fund P of Money X Company, Ali is able to have some stake in all these securities.
- Mutual Funds employ expert Fund Managers whose primary job is to pick and choose investments for your portfolio. They are also regularly monitoring the performance of the portfolio. Researching, picking, investing and monitoring securities may not be possible for individual investors who are busy with their daily life activities or for those who are new to the world of investing.
- Mutual Funds allow you to invest in a diverse universe of securities so that you don’t have to put all your eggs in one basket. The benefit of diversification is that if one stock doesn’t perform well, it can be compensated by other well-performing stocks in the portfolio.
- Mutual Funds also assist you in cross-asset diversification. It’s highly unlikely that if one stock isn’t doing well then, all other assets such as gold, commodities, bonds or real estate would also be performing worse at the same time. Therefore, Mutual Funds can assist you in spreading your money in a variety of asset classes so that you don’t take too much exposure or risk.
- Consider an example of buying donuts. Buying a dozen of donuts is cheaper than buying a single donut. In a retail store, buying more products may get you a discount on the total price. Similarly, with investments in Mutual Funds, investors can avoid transaction costs that they would have paid had they bought a single security. Buying 20 stocks separately means you will have to pay commission on purchase of each of that stock. However, a Mutual Fund with stake in these 20 stocks won’t charge you a fee on a per stock basis.