A fund is a type of investment in which individuals contribute to form a pool of money, which fund managers then use to invest in financial instruments like stocks and bonds. Each investor owns a percentage of the fund’s holding, denoted by units, proportional to their investment amount. The main aim of a fund is to generate good returns for its investors.
In this article, we will understand what funds are, how they work, the different types of funds, and the advantages of investing in them.
What are funds?
A fund is a collection of cash saved for a pre-defined or specific purpose that is managed either by an individual or a professional with the aim of growing its value over time. Some of the most common types of funds we come across on a daily basis are mutual funds or investment funds that pool money from multiple shareholders or institutions so that the money can be invested in a portfolio of assets like stocks, commodities, shares, or bonds.
Simply put, funds are money set aside by individuals, institutions, or governments for future use.
Example of funds
Funds can be of several types depending on their source, purpose, and management structure. For example:
- An emergency fund, popularly known as a rainy day fund, is kept for unforeseen situations.
- Many individuals also have college funds to save for higher education fees.
- Trust funds consist of cash saved and invested on behalf of a beneficiary, who gains access to all or part of the funds after a specified period.
- Retirement funds are set up to accumulate savings over a person's working years to provide income during retirement.
How does a fund work?
An investment fund is a collective investment vehicle in which many investors come together to create a sizable amount, which is then given to an experienced fund manager.
The fund manager then purchases a combination of assets like shares, bonds, stocks, short-term debt, etc., to ensure diversification that forms the basis of a well-balanced portfolio. The investors in return are given shares in the fund, which reflect how much money they have contributed.
The types of funds invested in depend on the fund’s objective and the risk appetite of the investors. These funds are then monitored, managed, and adjusted based on market conditions.
Types of funds
There is a broad range of investment funds to consider. Here are some of the most popular ones:
- Traditional mutual funds
- Index funds
- Exchange-traded funds (ETFs)
- Target date and target allocation funds
- Money-market funds
- Real estate investment trusts
- Hedge funds
Let us understand all of the above in detail:
Traditional mutual funds
These are the most popular types of funds in the Indian market, with a little over 4 crore individuals investing in mutual funds today. Traditional mutual funds help you buy equity, debt, or a mix of both to give you a diversified portfolio containing stocks and bonds. The shares of this fund are traded, i.e., bought and sold at the end of each trading day. Decisions are made based on market research and analysis.
Index funds
Instead of investing in one particular stock, index funds track particular market indexes like Nifty or Sensex. Unlike mutual funds, these are not actively managed but they passively track the composition of an index to provide investors with a cost-effective way to gain exposure to broad market segments. Thus, these funds aim to replicate the performance of a specific market index, such as the S&P 500.
Exchange-traded funds (ETFs)
ETFs work similarly to mutual funds and give you exposure to a diversified mix of bonds and stocks. The only catch is that, unlike mutual funds, they can be traded like stocks throughout the day over a stock market exchange. They can be managed actively or passively and can track other indexes, commodities, sectors, etc.
Target date and target allocation funds
Target allocation funds maintain a fixed allocation of assets, catering to investors with specific risk profiles. These are a subcategory of mutual funds that operate keeping in mind a target, typically for college education or retirement.
You start by selecting a target year for when you will need the money. You then invest in the target date funds, where the fund manager will adjust the fund’s asset allocation—aggressive in the beginning (accumulation phase) and more conservative as you are about to reach your target.
Money market funds
These are extremely low-risk and high in liquidity and can be easily converted to cash. Money market funds generally invest in secure short-term interest-bearing financial instruments like commercial paper and treasury bills, which are known to offer low returns but are considered the most secure.
Real estate investment trusts
REITs, or Real Estate Investment Trusts, are companies that pool money from investors to own and operate real estate like offices and malls for income generation. Individuals invest their money in REITs to generate regular income and long-term capital appreciation, similar to mutual funds.
Hedge funds
This investment avenue caters mostly to high-net-worth individuals or institutional investors who have the appetite to employ riskier trading strategies like short selling, derivatives, and leverage to generate higher returns. These funds charge a high-performance fee from their investors.
Advantages of investing in funds
- Diversification: With funds, investors have the option to invest in different asset categories, which reduces the risk that comes with investing in individual securities.
- Professionally managed: Fund managers have expertise in selecting and managing investments that have the potential to generate higher returns as opposed to retail investors.
- Liquidity: Some funds are quite liquid, allowing you to buy and sell them easily.
- Cost-effectiveness: Some funds have lower expense ratios compared to investing in individual securities, making them cost-effective investment options.
How do you start a fund?
Before you start a fund, the first question you need to ask is, what type of fund do you want to start with? Suppose you want to start a fund for emergencies (emergency fund). In that case, you must keep a small amount of money periodically—monthly or quarterly—in a separate banking account.
However, starting an investment fund is not as simple. You would need some professional experience in financial services and raise money from investors to cover initial expenses and operational costs. Then, you will have to decide your goals and investment strategies and get more investors to give you their money to grow your fund.
What is the purpose of a Fund?
The purpose of a fund is to allocate a specific sum of money for a particular goal. For example, an emergency fund is meant for unexpected expenses that arise during emergencies. Investment funds pool money from various investors to generate returns. College funds are typically set up by parents to save money for their child’s future education. Each type of fund serves a distinct financial need, whether it's for immediate use, investment growth, or future expenses.
Key takeaways
- Funds pool money from multiple investors, which fund managers invest in assets like stocks and bonds to generate returns.
- Various fund types include mutual funds, ETFs, index funds, hedge funds, and REITs, each catering to different investment goals and risk appetites.
- A professional fund manager oversees the portfolio, ensuring diversification and managing risks based on market conditions.
- Funds offer benefits like diversification, professional management, liquidity, and cost-effectiveness.
- Initiating an investment fund requires expertise in financial services, raising capital, and establishing clear investment strategies.
Conclusion
With funds, investors can easily and conveniently deploy their capital for appreciation, income generation, or diversification of risk. If you have a specific need, you are bound to find a fund in the market to fulfil it.
If you are planning to invest in mutual funds, the Bajaj Finserv Mutual Fund Platform provides an easy and efficient method. The platform helps you compare mutual funds and choose the right mutual fund schemes to meet your financial ambitions. With its SIP calculator and lumpsum calculator, you can make informed decisions about how much to invest and estimate potential returns.
