Understanding Mutual Funds

In the first part of a series, Sampath Iyer shares information about what a mutual fund is and how it can help your money grow.

- Sampath Iyer

In the olden days, our parents used to keep their wealth hidden in various locations, right from inside a granary to burying it under a tree in the courtyard. The only purpose was to keep the wealth safe from being stolen. In those days the medium of exchange was gold and as gold was a precious commodity, appreciating in value, wealth could match inflation. However, when the medium of exchange changed and the use of paper currency came into being, idle wealth began losing value. This wealth did not grow at all, resulting in erosion of value. Thus was born the need to save and protect against inflation.

Initially, the government began promoting saving instruments through post offices to build the confidence of those who wanted to save for the future. This need to infuse confidence was necessary because of the bad experiences people had with money lenders’ exploitative methods. Banks also began aggressively sourcing savings to finance entrepreneurs. However, the rate of return of these fixed returns began losing shine because the rate of return was lower or around the inflation rate.

The investor population began moving from a secured fixed return to risky but higher return products and began investing in equities (stock market) where the returns over a longer period of time gave better returns than fixed deposits. However, an investment in equity was a very technical investment requiring highly educated and experienced professionals. As a retail investor could not afford this cost, mutual funds came into existence.

What is a Mutual Fund?