What is a Mutual Fund?
Essentially, the Mutual Fund is created when many people (investors) combine their resources to create a huge investable amount (corpus) to earn wealth. The mutual funds are managed by fund managers who study the market closely and select companies to invest in. They usually spend a lot of time analyzing the market and studying different sectors of the economy to understand which companies are more likely to turn a profit.
The money pooled in from the investors is invested across industries operating in different sectors according to the type of fund chosen. Investors of a mutual fund get to share the profit, loss, income, and expenses in proportion to the level of their investment.
Mutual fund schemes are created by companies known as Asset Management Companies (AMC) or Fund Houses. There are thousands of mutual funds offered by several AMCs and Fund Houses. Regulatory bodies such as SEBI and AMFI take the necessary precautions to ensure that no investor gets scammed. Additionally, global agencies exist that analyze and rate the performances of funds over time and ensure that the investors are informed in advance before investing.
What are the various types of Mutual Funds?
Mutual funds are classified based on investment objective, asset class, and structure. Also, there are specialized mutual funds.
1. Funds based on the investment objective:
Liquid funds: The main objective of liquid funds is to provide capital safety to its investors. These funds invest in debt instruments and include a portfolio that matures in around three months. The chief advantage of liquid funds is that the interest rate fluctuations in the market do not affect it and they have a huge potential of generating income.
ELSS or Tax saving funds: These schemes generate long-term capital by investing in stocks, equities, and shares. Investments made in ELSS are eligible for tax deductions under section 80C of the Income Tax Act.
Growth funds: The main objective of growth funds is to a great capital appreciation during the tenure of the fund. These are primarily invested inequities. Growth funds are ideal for investors who do not wish to retire or pull out their investments soon and are willing to take risks.
Income funds: These funds are invested in bonds, debentures, government securities, stocks with high dividend potential, etc., that provide investors with regular income. Income funds are ideal for investors having a low-risk appetite as they are actively managed and generate regular income. Beginners, pensioners, and conservative investors prefer income funds to other funds.
Fixed maturity funds: These are close-ended funds that invest primarily in debt instruments and have a predetermined maturity date. Fixed maturity funds are similar to fixed deposits and provide tax benefits. Unlike most other debt funds, fixed maturity funds adopt a buy-and-hold strategy which helps them reduce the overall expense ratio. However, unlike fixed deposits that offer assured returns, fixed maturity funds provide fluctuating returns.
Capital Protection Funds: As the name suggests, these funds protect investor’s capital during economic instability. It also provides capital appreciation and growth.
These funds are close-ended and cannot be interfered with during its lock-in period. Although historically, these funds have performed well, there is no guarantee that these funds will perform as well as advertised.
2. Based on the asset class
Equity funds: The major part of equity funds is invested in stocks and other related instruments of different companies. These funds are slightly riskier than other types of funds. Equity funds are recommended for people who are willing to wait for at least 5 years to see substantial returns and have the ability to take high risks associated with the funds.
Debt funds: These funds invest a majority of its corpus in fixed-income investments such as corporate bonds, money market instruments, treasury bills, government securities, and other debt securities. Debt funds are ideal for people who are interested in earning smaller and stable returns with greater liquidity.
Hybrid funds: Hybrid funds invest in equity as well as debt instruments to create long-term capital appreciation at a lower risk. Hybrid funds are also liquid to a certain extent and divert a part of the corpus into cash and other equivalent investments. These funds are ideal for new investors and experienced conservative investors.
3. Based on structure
Open-ended mutual funds: These funds allow investors to buy and sell units of the fund according to their convenience. Investors can exit the fund at any time and at the current Net Asset Value (NAV).
Closed-ended funds: In this type of funds, the fund tenure, total unit capital, investment avenues, etc., are pre-decided when offered for purchase. However, investors have to remain invested until the completion of the fund’s tenure and cannot buy or sell units during this time.
Interval funds: An investor can enter or exit from the fund at intervals determined by the fund house. Although these funds have a certain amount of liquidity, you cannot consider it to be a liquid investment as they can be redeemed only during specific intervals. Interval funds have benefits of both open and closed-ended funds and invest in private assets and assets that aren’t listed on any exchange.
You may also consider investing in specialized funds like Fund of funds, global funds, emerging market funds, sector funds, thematic funds, asset allocation funds, exchange-traded funds.
How do Mutual Funds work?
Different mutual funds operate differently from each other but all have some basic principles that they operate on. Mutual funds operate on:
A fund house identifies a potential earning possibility and calculates the risk and potential reward involved in this particular investment.
The fund house studies other related investment opportunities that could boost the value of the main opportunity.
The fund manager working for the AMC makes sure to choose and pick different investments to balance out the risk and total earning potential.
Details about the fund along with the risk factors are documented and submitted to SEBI for regulatory approval.
The fund scheme is made available to the public who can then purchase the fund units. The more units are purchased, the larger the investment and the potential income.
Once the investments are made, the fund manager will manage the funds either actively or passively.
Dividends are proportionally distributed amongst investors under the dividend option while the dividends are reinvested for capital appreciation under the growth option.
Capital gains are paid to the investors at the end of the fund’s tenure.
What are the benefits of investing in Mutual Funds?
Some of the benefits of investing in mutual funds are listed below.
They are easily accessible: It is easily to open an account and begin to invest in mutual funds. They are usually offered at banks, insurance companies, brokerage firms, and mutual fund companies.
Available in many categories and types: You can invest in mutual funds that cover the main asset classes such as stocks, bonds or cash and other sub –categories. You can even venture into specialized funds such as precious metals fund or sector funds.
Low minimum: Most mutual funds have minimum initial investment requirements. You can invest as low as Rs.500. If you opt for SIP, you can even fix a certain amount and ask your bank to deduct it from your account every month.
Investment expertise and experience: Investing in stocks requires a lot of expertise and experience while mutual funds are managed by professional fund managers who have sufficient expertise and experience in picking the right stocks so that you can get the best risk adjusted returns.
Different modes of investment: Mutual funds offer investors flexibility in terms of modes of investment and withdrawal. You can choose from modes like systematic investment plans (SIP), lump sum, systematic withdrawal plans, systematic transfer plans, switch from one scheme to another and so on.You may even consider the growth option or the dividend option according to your financial goals.
Economies of scale in transaction costs: The transaction costs per unit is much lower in mutual funds as they buy and sell securities in large volumes. It is lower than what retail investors may incur if they buy or sell shares through stock brokers.
What are the different ways of investing in Mutual Funds?
There are numerous ways in which you can invest in mutual funds.
Banks: Some banks have tie-ups with fund houses. You can visit the nearest bank branch and ask if they are selling any mutual funds.
Agents: This is one of the oldest and most common methods of investing in mutual funds. You can contact an agent who will guide you on which mutual funds to buy. Many agents are linked with companies that provide login facility. You can login and see how your funds are performing.
Asset Management Company (AMC): You can visit an AMC and invest directly. If you wish to invest in funds from different AMC’s then you will have to visit all of them. SIP is one of the best ways to invest directly through the asset management company.
Demat Account: You can invest through your demat account. However, you will have to pay a commission here. Demat accounts make it easier to control buying and selling of mutual funds.
AMFI website: The Association of Mutual Funds in India has a website that lists all the mutual fund agents across the country. You can locate an agent in your area by putting in your PIN code once you get the AMFI registration number.
Online: There are numerous web portals that allow you to invest in Mutual funds. All you need to is, open an account and they will send all the documents to your residence. However, it is advisable to check with your financial advisor before investing in mutual funds online.
Frequently asked questions
When should I start investing in Mutual Funds?
You can invest in mutual funds as early in life as possible.
What is the ideal amount to start investing in a mutual fund?
There is nothing like an ideal amount. You can start investing as low as Rs. 500 and as high as you wish to.
How can I start investing in Mutual Funds?
There are many ways by which you can start investing in mutual funds. The most common way is through an agent. Other ways include banks, AMCs, Demat account or online.
What is the benefit of staying invested in the long term?
Mutual funds undergo both good and bad times in the market. However, the average of it is always impressive. Long-term investment ensures that you get the best.
Mutual Funds vs Shares: What’s the difference?
Investing in mutual fund is mainly investing in stocks and bonds managed by a fund house/. Direct investment in shares and stocks is an active form of investment where you handle the purchase and sale of the products yourself.
Do Mutual Funds invest only in stocks?
There are many types of mutual funds meant for the varying needs of people. Each is associated with some amount of risk.
Do Mutual Funds issue a passbook?
Unlike the passbooks issued by banks, mutual funds issue an account statement.
What is the risk of investing in Mutual Funds?
Some risks such as market risk, credit risk, business risk, price risk and liquidity risk may arise from certain schemes.
How do I choose a Mutual Fund?
You must choose a fund depending on your risk appetite and financial goals.
Why should one invest in Mutual Funds?
Mutual funds offer various products and tools to fulfil different objectives. Investors can choose any product based on their financial objective.
Are Mutual Funds an ideal investment for the small investor?
Mutual funds allow investors to invest as low as Rs.500 every month and inculcate the habit of regular saving.
How can one track a Mutual Fund performance?
If you have invested through an advisor, you will get updates and review statements that will help you track your portfolio and its performance. Additionally, there are several websites and mobile apps that will help you keep track of performance. Fund Fact Sheet is a one-page document that can help track your investments.
Can Mutual Funds help create wealth?
Yes. Mutual funds are a great way to build wealth.
How do I withdraw my money from Mutual Funds?
Almost any scheme can be redeemed without any waiting period unless the scheme offers tax benefits under section 80C or they are close-ended schemes.
What are the kinds of financial goals I can fulfill with Mutual Funds?
Whether it is long-term or short-term, Mutual Funds help you achieve any financial goal. ELSS schemes are specifically designed to help you save tax.
Can NRIs invest in Mutual Funds in India?
Yes. As a matter of fact, both NRIs as well as PIO(Persons of India Origin) can invest in mutual funds in India.
Are Mutual Funds offered by Banks?
Many banks function as distributors of mutual funds. They operate as sales channel for the funds they have tied-up with for distribution. However, banks may not sell all the funds available in the market.
What affects the performance of a Mutual Fund?
Every mutual fund is managed by a designated fund manager who is responsible for the fund performing optimally. Additionally, fluctuations in the market, equity or debt also affect the performance of the mutual fund.
What are some mistakes people make when investing in Mutual Funds?
Some of the common mistakes people make while investing are;
Investing without a plan
Investing without understanding the product
Investing without knowing the risk factors
Not investing the right amount
Joining the herd