why mutual funds

Why invest through mutual funds

The benefits of investing through mutual funds have been elaborated below.  The simple fact is that most people do not have time outside their work and family life to scrutinize dozens of stocks and bonds before putting their money in for investment.  This job can be left to professional managers.  Anyone can pick and buy certain hot stocks and make money in the process.  However, this fact should not make us believe that we will always hit a sixer.  It is an established fact that majority of part-time speculators lose in the game of speculation.  One should not confuse speculation for investment.  Investment through mutual funds is an ideal option for those investors who do not have time to explore investment opportunities in today’s dynamic and ever changing capital market conditions.

The benefits of investing through mutual funds

Mutual funds allow investors to benefit from the collective strength of the group (pool).  The benefits include:

Services of Investment Professionals

An average investor may not be well-versed with the capital markets, or have access to adequate information to invest successfully or simply may not have the time to acquire information and analyze it.  By investing through a mutual fund, the investor is able to acquire the services of a team of professionals dedicated to the investment business, whose cost is spread over the entire pool and thus is at a very low cost for the investor.

Ability to Diversify

An average investor will normally invest small amounts of money and will not be able to achieve an adequate level of diversification if invested directly in the Capital Market.Where as even a small amount in a mutual fund will achieve immediate diversification by becoming a part owner of the entire portfolio of the mutual fund.  This has been dealt with previously in the Diversification section.

Ability to invest very small amounts

An investor, who wishes to invest very small amounts, even Rs. 1,000, can do so by investing in some mutual funds (normally open-end funds).  The same amount of Rs.1,000 will not be entertained by any broker in the capital markets, which are normally the exclusive domain of the rich and wealthy.

Ability to multiply savings

If an investor wishes to build up savings of small amounts every month, he does not have to wait to first build up large enough amounts to invest meaningfully. By investing every month in a mutual fund, the investor can make the monthly savings earn and grow as these are accumulated.

Ability to diversify price volatility risk

At the point in time when an investor has some funds to invest, the market may be rising (bullish) or declining (bearish).  He is never too sure if he is entering the market at the right time.  By investing small amounts in mutual funds regularly, the investor is able to average out the fluctuations in the purchase price – some investment will be made when the market is high and some when it is low; the average investment is likely to be at the mid-point.

Ability to match investment with risk taking ability

Most investors have their own unique risk taking ability. Retired persons will normally have a low risk taking ability.  On the other hand, younger persons or persons with adequate resources are normally able to take higher risk and should therefore be able to benefit from higher potential rewards.  Mutual funds normally offer different investment styles, i.e., there are funds that invest in the stock market and carry a higher potential risk and reward.  Apart from stock market funds, there are mutual funds that invest in the debt securities, which expose one to relatively lower risk; and then there are mutual funds that invest in money markets, which expose one to very low risk.  By allocating one’s savings into several mutual funds, the investor can balance out the investments into a combination that suits the investor’s risk taking ability.

Less volatile

By investing in diversified assets, mutual funds are generally less volatile than the average equities portfolio of an individual investor.

Size does matter

With the growth in the size of funds under mutual fund management, the reach and dimension of that fund in itself enhances its ability to exploit investment and trading opportunities in the market.

Liquidity

Money invested in mutual funds can be redeemed either by selling the shares of a closed-end fund in the market or by simply asking the Fund Manager for redemption (refund at current market price) in the case of an open-end fund.  There are no penalties for early termination of the investment, which one may have to suffer in the case of term deposits with banks or other savings schemes.

Protection of Regulation

If one invests directly in the capital markets, the rule of Caveat Emptor or “buyers beware” applies in its full meaning.  However, in case of investing in a mutual fund, one is protected by the government-enforced regulation of mutual funds.  In most countries, Mutual Fund Managers are regulated under stringent regulatory rules and investors can rely on the enforcement of good practices by the Fund Managers.  In Pakistan, the Securities & Exchange Commission of Pakistan (SECP) is the regulator of mutual funds and is very stringent in issuing licenses to fund management companies, especially in the case of unit trusts.  The SECP also carries out continuous monitoring of mutual funds through reports that the mutual funds have to file with the SECP on a regular basis.

Protection through the Trustee

In the case of unit trust schemes, the trustee, who has to be qualified under the law to act as such, offers additional protection by having complete custody over the assets of the mutual fund.  The trustee ensures that the Fund Manager takes the investment decisions within the defined investment policy of the mutual fund.  Under Pakistan law, banks and central depository companies, approved by the SECP, can act as trustees.