According to Mr. Warren Buffet, if Mr. Isaac Newton, the famous scientist had researched a bit more in the share market, he might have discovered the fourth law of motion. Buffet made this statement because Newton had previously invested in the South Sea company where he faced a huge loss. So what would’ve been this fourth law? Let us find out.
In the year 2005, Warren Buffet had challenged the entire mutual fund industry. What is this Mutual Fund and what was that challenge? Many people have a query saying you always recommend Index Fund. But what do you mean by an Index Fund?
Firstly, the reason why people invest in the share market is that the returns that we earn from investing in Safe Asset Class are very low as compared to the returns achievable from the share market. Now, there are two ways in which you can invest in the share market i.e. either directly or indirectly.
Direct investment requires you to have a Bank account connected with a Demat as well as a Trading account with a share broking house. If you wish to open your demat and trading account, you’ll require your mobile number to be linked to your Pan Card & Aadhaar card. Also, as you know Aryaamoney has started tying up with leading brokers amongst which the first is Upstox. So if you wish to open your account with Upstox, you can click on the link given below the blog. In Indirect Investment, we invest in the share market through a middleman or agent as in mutual funds.
What are Mutual Funds? Let us understand this with the help of a simple example. Consider there’s a person called Ramesh. Now, Ramesh thinks that the share of Reliance Industries is going to increase by a great margin. The problem here is, Ramesh only has Rs. 500/- with him and the price of a single share of Reliance Industries is around Rs. 1500/- at the moment. Now, Ramesh has a friend named Suresh. So Suresh also thinks that the share of Reliance Industries is going to go up but he too has only Rs. 500/- with him. They both have a third friend called Dinesh. Dinesh also feels the same that the share of Reliance Industries is going to rise further. But he too has only Rs. 500/- with him. Now, if all the three come together and decide to invest in the Reliance Industry share then they can do so and then later divide the profit equally amongst the three of them. This philosophy of them coming together and investing is known as Mutual Fund.
In this manner, earlier all the three of them had thought that the share price of Reliance Industries was going to increase but they soon realized that it won’t be possible for keep to sit and carry-out the analysis all the time. Now, they think why not try and find someone who will carry out the analysis on their behalf and invest in the market accordingly. So it’s not just them but there are a lot more such people who think in this manner. Hence, when too many such people go to a company having a Fund Manager who collects funds from various people and carries-out a proper detailed analysis and then accordingly invests the fund in the market. Being a Fund Manager, he won’t do this for free. He will charge a specific percentage of commission.
When these funds are further taken to the company for fund management that is called an Asset Management Company. This fund which is managed is known as a professionally managed Mutual Fund.
The fee structure of Mutual funds falls into two categories basically, the first category is Regular Mutual Funds. In Regular Mutual Funds, you invest in the market through an Advisor who also charges a commission. So here, the expense ratio is a bit on the higher side. The second category is Direct Mutual Funds. Here, you by yourself research and find a mutual fund and then invest in it directly through the Asset Management Company without having the advisor in middle. In this way, you don’t need to pay commission to the advisor and thus, your expense ratio also comes down.
The Fund Managers in mutual funds can manage the funds in two ways either actively or passively. What is the difference between active and passive management? When you invest in the market for the long-term, you do so that you can earn good returns in the long run. How are these good returns possible? So, if the Sensex & Nifty indices perform well in the market, you can earn good returns. The next question is, if Sensex & Nifty perform well, how will be earning good returns from it? The answer is simple. You can do so through passive fund management.
Let us understand this Passive Fund Management. The Fund manager here as well as the people investing in passive funds believe that Sensex & Nifty i.e. Index will perform very well shortly. So the Fund manager will invest the fund in the companies that are in Sensex & Nifty i.e. the Index. So as and when Sensex and Nifty will increase the fund will increase too. It means this fund will perform just the way the Index performs. This is known as Passive Fund Management. As this fund does not require much analysis and research, so here the fund management charges are also low.
The other is Active Fund Management. In Active fund management, the fund manager not only invests in the shares of companies present in the Sensex & Nifty respectively but he is allowed to invest in the other companies listed on the stock exchange as well where he thinks there are certain value and growth potential. Thus, he actively manages this fund. Active Fund Management involves a lot of analysis and research, so here the expense ratio is also more as compared to Passive Fund Management because here the funds are managed actively.
To know more about the Warren Buffet Challenge and the Mutual Funds industry, continue to read our next blog.
Till then…
Happy Trading, Happy Investing!!!
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