Who doesn’t want to grow rich? The fastest way to grow rich is an investment in mutual funds or shares. The old saying holds true. If you want to enjoy high returns, you must take high risk. An investment in shares and mutual funds involves high risk, but you get to enjoy high returns. In this article we will tell you what are equity shares and mutual funds, in a real simple way.
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Let's say you want to start a business and need Rs 10 Lakhs. You only have Rs 6 Lakhs, so what will you do? You will borrow Rs 2 Lakhs from 2 friends and with the Rs 4 Lakhs, you run the business. You have 60% share in the business and your friends collectively own the remaining 40%.
The total equity capital of your business is Rs 10 Lakhs. Your business is running cool and you want to expand it. You need another Rs 10 Lakhs to make the equity capital Rs 20 Lakhs. You need more money, but this time you don't ask friends. You just spread the word around that you are planning to expand and anyone is welcome to contribute. This is called a public offering.
Exactly 10 People come forward giving Rs 1 Lakh each. Thus each of them becomes a shareholder of the company, holding 5% share each (1,00,000 /20,00,000*100). If you divide the Rs 20 Lakhs equity capital into 20 parts of Rs 1 Lakh each and call each part a share, then every person holds 1 share of the company. Got the idea?
Now if a Company is small it is easy to buy/sell shares, but when a large investment and many buyers/sellers are involved it gets difficult. This is where a stock exchange like NSE and BSE comes in, to help you buy and sell shares of small, medium and larger Companies. You can buy and sell shares of hundreds of Companies on a stock exchange. A stock exchange does not own shares. Instead, it acts as a market where share buyers connect with share sellers.
If a company is doing well, you would love to own a part of it, thus the price of shares of that company would increase due to the rise in its demand. If a Company is not doing well, you will sell shares and with many people selling, the price of the shares would fall.
A mutual fund collects and invests your and other investor’s money in shares (equity), bonds (fixed income where your money is safe and you earn interest) or even a mix of shares and fixed income called balanced funds. The total investment made by the mutual fund house, either in shares, fixed income securities like bonds or a mix of both, is divided into units.
Depending on the amount you invest, you are given units of the mutual fund. The NAV (Net Asset Value), gives you the value of the mutual fund. A reputed fund manager manages the money and invests in shares, fixed income or both, depending on the type of mutual fund.
SEE ALSO: Mutual Funds Sahi Hai?
Let’s understand equity mutual funds where most of your money is invested in shares. Before investing in mutual funds make this decision. Are you an aggressive investor willing to take risks for higher returns OR are you conservative and don't like taking risks.
If you want higher returns taking higher risks you must invest in equity diversified mutual funds where most of your money is invested in shares of different Companies across sectors (finance, automobiles and so on). If one sector fails the other may do well and your investment is somewhat protected. You need to stay invested in equities for the long term at least 3-5 years to get good returns.
There are other types of equity funds like sector funds which invest all your money in a single sector. These are extremely dangerous because if the sector collapses you lose the investment.
An investment in equity mutual funds is risky because your money is invested in shares which go up and down based on the Company performance and general economic conditions.
Let’s understand debt mutual funds where most of the investment/money is in fixed income like bonds. The manager invests your money in fixed income where your investment money is safe, and earns some interest. Debt funds are safer than equity funds, but don't give high returns compared to them. If you are conservative and like to take less risk for a moderate return, go for debt funds.
You can also invest in balanced funds where part of your money is invested in shares/equity and part in debt (fixed income). When stock markets do well, the equity portion gives good returns. When stock markets crash, the debt portion cushions your investment. If you want decent returns with lesser risk, opt for balanced funds. Be Wise, Get Rich.
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