Mutual funds are recognized as one of the most accessible and popular financial instruments. Mutual funds pool money from investors to buy stocks, bonds, and securities and are managed by a professional fund manager. It is a trust that has a set of investment objectives declared in the fund’s prospectus. People who invest in mutual funds will receive a portfolio that matches the stated investment objectives. This diversified portfolio includes stocks, bonds, or other securities.
It is the function of the fund manager to invest the pooled money into various securities and monitor its growth. These investment decisions are arrived at based on the objectives and strategy of the particular mutual fund. The gain or loss of the fund is shared collectively by all the investors in proportion to their investment.
Let’s try and simplify this:
Imagine a mutual fund as an art gallery where individuals come together to collectively invest in a diverse collection of artworks. Think of the investors as art enthusiasts who pool their resources to acquire a wide range of art pieces. The gallery, representing the mutual fund, houses a curated collection of paintings (equivalent to stocks), sculptures (bonds), and rare artifacts (other securities). The gallery curator, similar to the fund manager, is tasked with selecting which art pieces to acquire, determining the mix of paintings, sculptures, and artifacts, and deciding on the timing of purchases and sales.
By investing in the gallery, each art enthusiast gains part ownership in all the pieces within the collection. This arrangement allows investors to enjoy a varied portfolio of artworks, offering exposure to different styles, periods, and artists that would be challenging to achieve through individual investments. The diversified collection mitigates risk, as the impact of any single art piece’s depreciation is cushioned by the overall value of the gallery’s holdings.
Types of Mutual Funds- Schemes Based on Structure
Open Ended and Closed-End Scheme
An open-end fund is a type of mutual fund scheme that can be invested in and redeemed throughout the year. It does not have any maturity date.
A closed-end mutual fund is open for subscription only during the initial offer period. It operates with a defined duration and fixed maturity period. Redemption of units is restricted until maturity and does not allow premature redemption. Consequently, the stock market will only list the units of closed-end funds after the new fund offer. These units are then traded on the exchange like regular stocks. Investors can sell their units if they wish to exit the scheme before its maturity date.
Actively Managed and Passively Managed Funds
An actively managed fund is a type of mutual fund where the fund manager proactively manages the portfolio. The manager consistently monitors and makes decisions regarding buying, selling and holding based on his professional judgement based on analytical research. The primary objective of this fund is to achieve the highest possible return.
In contrast to actively managed funds, passively managed funds adhere to a market index. Here, the manager remains inactive and refrains from using his judgment to decide which stock to buy, sell and hold. Instead, the fund tracks the benchmark index of the scheme precisely. The primary objective of a passive fund is to replicate the returns of the scheme’s benchmark index without attempting to outperform it. (The benchmark index of a particular mutual fund is the index against which the scheme intends to calculate its performance)
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Types of Mutual Funds Based on Asset Class
Mutual funds can be categorised based on the asset class they primarily invest in. They are:
Debt Funds
It is also known as fixed income funds as it invests in fixed incomes such as government and corporate bonds. It is suitable for investors’ regular income and capital preservation. It is relatively risky as it offers a reasonable return. Debt funds are for you if you want a study income without risk.
Equity Funds
Equity funds invest your money in stocks. Its principal aim is capital appreciation over the long term. Returns on equity funds depend on market movement; hence, they have a higher risk factor than debt funds. Equity funds are better investments if you plan to invest for long-term goals like buying a house or retirement planning. Since, over the long term, the level of risk may be reduced.
Hybrid Funds
If you want equity and debt funds in your investment portfolio, hybrid or balanced funds are your best choice. It will cater for a balanced approach with income generation and capital appreciation. Based on the investment in assets and debt, hybrid funds are subcategorised into various other types.
Types of Mutual Funds Based on Investment Objectives
Based on investment objectives, mutual funds can be further categorized.
Growth Funds
As the main objective of this fund is capital appreciation, these funds put a significant portion of money in the stock market. It is risky due to the high exposure to market volatility and, hence a better choice for long-term investment.
Income Funds
As the name suggests, its main objective is to generate a stable income. This fund mostly invests in government securities and is suitable for investors with low-risk capacity.
Liquid Funds
It is an investment where you can put your surplus money for the short term or keep it as an emergency fund. This fund puts cash in short-term money market instruments like commercial papers, treasury bills, and certificates of Deposits.
Tax Saving Funds
Income Tax Act 80C provides tax exemption benefits to this type of fund. Investing in this type of fund, like the Equity Linked Incentive Scheme, will give you a tax deduction of 1.5 lakhs a year.
SIP and Mutual Funds
What is a Systematic Investment Plan (SIP)?
The systematic investment plan is a method of investing in mutual funds. You invest a specific amount at fixed intervals, like a recurring deposit. In this method, you only need a small amount of money to start investing. Most of the funds in the country allow people to invest ₹500 per month and, in some cases, as low as ₹100.
Benefits of SIP
- Regular investments
- Affordability
- Compounding Benefits
- Long-Term Wealth Creation
- Diversification
- Flexibility
Mutual Funds Vs. Index Funds
Index funds are a type of mutual fund where investment corresponds with a vital market index, such as NIFTY 50. This method requires less research and analytics from advisors. Consequently, the expenses passed on to shareholders are lower. The primary objective is to minimise the cost and closely reflect the market index. It is a type of passive fund with a low expense ratio.
Returns On Mutual Funds
Investors usually receive money from mutual funds in three different ways.
1. Income: Income receives from the interest on bonds and stock dividends in the fund’s portfolio.
2. Portfolio Distribution: The fund may sell securities that have increased in price to gain capital gain. The fund will distribute the gain among the investors.
3. Capital Gains: When the share of the particular fund increases, the investor can sell the mutual fund share in the market and gain profit.
Mutual Funds Calculator
Most mutual funds will have a mutual fund calculating tool where you can calculate the potential return on your investment based on various parameters. Typically, the critical inputs required for a mutual fund calculator are:
- Investment amount
- Systematic Investment Plan (If applicable)
- Investment Duration
- Expected Annual Return
- Frequency of Compounding
Benefits of Investing in Mutual Funds
There are many benefits to investing in mutual funds. Some of the benefits are given below-
Professional Management
If you want to invest in the market but need more time and expertise to follow and analyse the market trends, a mutual fund is the best choice. A professional manager will work for you even with the minimum investment. He will use his analytical skills and expertise to gain maximum return. You only need to pay a specific amount to the professional manager, and he will take care of your investment.
Tax Benefits
Mutual fund investors can avail of a tax deduction of up to 1.5 lakh through equity-linked savings (ELSS) as per section 80C of the Income Tax Act. The advantage of this tax benefit is that it is applicable with a lock-in period of 3 years for ELSS funds. But you can withdraw funds only after the completion of this period.
Indexation benefit available on debt fund is another benefit. While conventional products require taxation on all earned interest, only returns earned over and beyond the inflation rate are subject to tax. It could earn the investor a higher amount after deducting the tax.
Diversification
Diversification is mixing assets and investments within a portfolio to reduce risk. When you put all your investments in a basket, the chances of loss due to a market crash are higher. Mutual funds, on the other hand, provide an opportunity to invest in diverse asset classes.
If you were investing individually, you would have to choose multiple stocks and invest to achieve this diversified portfolio. But when you invest in a mutual fund, with a single fund, you will have access to as many as 30 stocks. You will have a diverse portfolio with cheaper investments and mutual funds with less risk.
Challenges of Mutual Fund Investment
No Guarantees
Like any other investment, mutual fund also has the possibility of depreciation. But you can choose the mutual fund that matches your requirements and risk adaptability.
High Cost to Manage the Fund
When the returns on your investment are higher, the cost you are paying to manage the fund will be reasonable. However, regardless of the profit and loss, you must pay the fund manager a particular amount. It will be disadvantageous when you do not receive sufficient returns because of the market volatility.
Exit Loads
Some mutual funds charge exit loads if investors redeem their funds before the specified period. The purpose of this charge is to discourage short-term trading and compensate for the loss that the fund may have to bear. It is a fine for premature withdrawal of your investment, but it acts as a motivation for long-term investment.
Lack of Control
Investors do not have direct control over the decisions regarding fund allocation to different assets. It is the fund manager who decides the portfolio allocation, which may be different from the interest of the investor. The best way to avoid this will be to go through the objectives listed in the particular mutual fund before investing.
How to Invest in Mutual Funds?
Investing in mutual funds is a comparatively straightforward process than directly investing in the share market. Here are the steps to follow while investing in mutual funds. Don’t forget to add your steps matching with your goal.
- Set Your Finacial Goals
- Understand Your Risk Tolerance
- Do some research
- Choose a Suitable Mutual Fund
- Select a Mutual Fund Investment Platform
- Complete KYC process
- Open an Investment Account
- Choose Investment Mode
- Provide Bank Details
- Initiate the Investment
- Monitor and Review
Now that you know everything about mutual funds, research, and investment,
FREQUENTLY ASKED QUESTIONS
1. Are mutual funds safe?
Mutual funds are relatively low-risk investments. However, market volatility can cause a loss in mutual funds like other investments.
2. Who regulates mutual funds in India?
Securities and Exchange Board of India (SEBI) regulates mutual funds in India. SEBI governs all aspects of mutual funds, from their establishment to their fees.
3. Can you invest one time in mutual funds?
Yes. Lupsum investment allows you to invest a substantial amount of money at once.
4. Are there mutual funds available in India without a lock-in period?
Most of the mutual funds in India do not have a lock-in period.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully. The NAVs of the schemes may go up or down depending upon the factors and forces affecting the securities market including the fluctuations in the interest rates. The past performance of the mutual funds is not necessarily indicative of future performance of the schemes. The Mutual Fund is not guaranteeing or assuring any dividend under any of the schemes and the same is subject to the availability and adequacy of distributable surplus. Investors are requested to review the prospectus carefully and obtain expert professional advice with regard to specific legal, tax and financial implications of the investment/participation in the scheme.
While all efforts have been taken to make this blog as authentic as possible, please refer to the print versions, notified Gazette copies of Acts/Rules/Regulations for authentic version or for use before any authority. We will not be responsible for any loss to any person/entity caused by any short-coming, defect or inaccuracy inadvertently or otherwise crept in this blog.
