Any idea about what’s the most loved day of the year? According to research (and that’s my research of course!), it’s the first day of each month! After long endless hours of work, snoozing your alarm 5 times before eventually getting up and constantly tolerating your bosses’ nagging about how poor your work is, you finally get an SMS from your bank. Guess what? 30,000 has been deposited to your bank account! Hurrah! Let’s throw a party and hibernate for a year. Unfortunately, this is only going to make me work for 50 more years – something I badly want to avoid.
That brings us towards the gist of our topic: how do you make good simple investments, which ensure that your income grows each year? One such investment and a personal favorite of mine, goes by the name of Mutual funds. Yes, the name does sound too “finance freaky” and most likely your mom is going to tell you to put a car in Careem after hearing this name but believe me this is the simplest of all investments that will certainly increase your wealth.
So, what is a Mutual fund?
In simple terms, Mutual fund is a pool of money gathered by a firm from individuals like us and invested in different investment alternatives such as stocks, bonds, other debt related instruments etc. The money generated by these investments is then returned back to us. So, for example, I can take some of my money to a Mutual Fund firm, choose the type of the mutual fund I would like to invest in and get paid on a yearly basis for investing my money.
Simple, isn’t it? Yes and No. It does have some risks associated with it, but so does every investment. That certainly does not mean you should put a car in Careem instead. Understanding risks and forming strategies that tackle those risks, is what makes you a good investor. Before we take a detour into the apparent risks, it is worth mentioning a few more details about Mutual funds.
Decoding jargons of a Mutual Fund
One interesting thing about finance professionals is that they make everything sound as if it is too complicated. If you feel like they are speaking Chinese, it’s certainly not your fault! Let me try and help you out in making you understand the terms you might encounter on the subscription form of Mutual Funds:
Types of Mutual Funds
There are basically 3 types of Mutual funds available to investors:
- Open-ended Mutual funds – By far the most widely-used funds in Pakistan, as well as around the world. You can simply invest in these funds by examining the NAV of 1 unit and buying the required units. For example, if the NAV is Rs. 50 and the minimum investment required is Rs. 5000, you get a total of 100 units. Assuming, NAV does not change a year later, you can sell 100 units for Rs. 5000. Moreover, open-ended funds have no set limit to the number of units that can be sold
- Closed-ended Mutual funds – Less commonly found in Pakistan, Closed-ended funds are sold in a pre-determined quantity and traded on a stock-exchange. That is, similar to stocks, they have their own price, and can be bought and sold by investors through an exchange. Also note that unlike open-ended funds, their prices are not determined by their NAV.
- Exchange traded funds (ETFs) – ETFs are identical to the Closed-ended Mutual funds and are traded on an exchange. However, their prices cannot move (up or down) at more than 1% of their NAV
Benefits of investing in Mutual Funds
- Diversification – Don’t put all your eggs in one basket! My Finance 101 professor used to repeat this phrase in each and every class. Rightly so, a prudent investor should never put all of his/her money in one or two assets. However, it gets extremely difficult to buy several different assets. Enter Mutual funds, the savior of this generation’s money, offering benefits of diversification by investing in several different asset classes. So folks, even if you buy 1 unit of a mutual fund, remember that your money is invested in numerous (sometimes 100s and 1000s) different assets!
- Professional management – Do you have the time to research about all the possible investment alternatives? If I did that, I’d be fired by now! However, Mutual Funds are managed by professional investment executives who have the time, expertise and experience to do these kinds of research
- Liquidity – If you need to withdraw some money from the mutual funds, that shouldn’t be a hassle for you. Open-ended mutual funds have abundant liquidity and investors can easily get their money at NAV. However, this might not be the case for ETFs and closed-ended mutual funds that lack liquidity to some extent
- Tax benefits – Mutual funds in Pakistan benefit from tax advantages. Income (dividends or coupon payments) are taxed at a very low rate. Moreover, if you would want to sell the units at a higher price, you will be charged a low rate of interest, subjected to some conditions
- Different choices of funds – Do not prefer income in the form of interest? No problem! Various different types of Islamic mutual funds are available that would allow you to make receive income from “Halal” sources. Apart from that, you can choose whether to invest in funds that just have stocks and bonds of certain type or even Gold in their portfolios
Also, view our blog on Top 5 Conventional Mutual Funds in Pakistan.
Risks of investing in Mutual Funds
- Price of units may go down – Just like the price of stocks, Mutual Funds run the risk of a losing their value. This is despite the fact that you might enjoy the benefits of diversification as mentioned above. So, for example, if you invest Rs. 5000 in a particular fund, you might not get the entire amount back a month later if it drops in value
- Different types of fee – Every Cinderella story has a villain, and this is ours. Management charges a fee regardless of how the fund performs. This fee can range from 1% to 5%, which can substantially lower your earnings. Couple that with entry and exit fee and your return might be considerably lower than what you actually thought
- Lock-in period – Some Mutual funds prevent investors from withdrawing their money before a particular period. This period may range from 1 to 5 years, depending on the type of fund you invest in
There are several different types of Mutual funds available in Pakistan’s market. The following table lists a few:
Thus, Mutual Funds are a convenient way to invest in a wide variety of asset classes, at a considerably low price. Finance professionals often advice investors to invest in this instrument for at least 3-5 years, in order to fully benefit from a rise in the value of units and short-term interest (profit) or dividend payments. Our next few blogs provide details of the top Islamic and Conventional funds available in Pakistan. So go ahead and check them out!