Let’s understand this difference with the help of an example:
A company – ABC Limited – wants additional funds to expand its operations. It has two choices:
It chooses the second option and offers ‘shares’ through an Initial Public Offering (IPO). Once these shares are issued by the company, the shareholders have a stake in the profits which is received by them in the form of dividends.
Ram is an IT executive who wants to invest in the shares of ABC Limited. However, when he has funds available for investment, the IPO is already over. He approaches Viren who already owns 50 shares of the company and asks him to sell the shares. Viren agrees to sell them at a price higher than his purchase price in order to book profits. Ram feels that ABC Limited will do great business in the future and agrees to buy at the price quoted by Viren.
This cycle continues and the shares keep changing hands. As the perception of the company doing good business - increases, the demand for its shares goes up and so does the price.
As mandated by SEBI, each AMC needs to provide three important documents to inform investors
a. Scheme Information Document (SID)
b. Key Information Memorandum (KIM)
c. Statement of Additional Information (SAI)
In the market, the stock exchanges facilitate such transactions, commonly known as secondary market transactions.
Vikram is a doctor who decides to start investing and building a corpus for his retirement. He starts looking at investment options available and the stock exchanges look promising. However, he lacks the knowledge and expertise required to choose the right companies to invest in.
On the other hand, Parth, who is a Customer care manager has immense knowledge and understanding of the stock market. He knows which companies are doing well and which ones have a better chance of doing well in the future. His friends and colleagues trust his understanding of the market and often ask him for tips on investment.
Parth decides to organize this sporadic investment guidance and make some money in the bargain. He asks his friends and colleagues to give him their funds so that he can invest and manage the investment on their behalf. He would charge a small administrative fee for these services. Vikram is Parth’s friend and gives him his funds for investment too.
This is what a Mutual Funds does. A Fund Manager manages funds invested by various people with common investment objectives across various investment options like shares or stocks.