What is a ‘Mutual Fund’
A mutual fund is an investment vehicle made up of a pool of funds collected from different investors for the purpose of investing in securities such as stocks, bonds, money market instruments, and similar assets. Mutual funds are operated by fund managers, who invest the fund’s capital collected from the investor’s an attempt to produce capital gains and income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.
One of the main advantages of mutual funds is they give small investors access to professionally managed, well-diversified portfolios of equities, bonds and other securities. Each shareholder, therefore, participates proportionally in the profit or loss of the fund. Mutual funds invest in a wide amount of securities, and performance is usually tracked as the change in the total market cap of the fund, derived by the aggregating performance of the underlying investments.
Mutual fund units can typically be purchased or redeemed as needed at the fund’s current net asset value (NAV) per unit, which is sometimes expressed as the NAV per unit.
A fund’s NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding.
Types of mutual funds in India
1.) Equity Funds
Equity funds invest most of the money that they gather from investors into equity shares. These are high-risk schemes and investors can also make losses, since most of the money is parked into shares. These types of schemes are suitable for investors with an appetite for risk.
You can choose from different types of equity mutual funds including those that specialize in growth stocks, income funds, value stocks, large-cap stocks, mid-cap stocks, small-cap stocks, or combinations of these. Some specialty equity funds which invest in a particular sector are health care, commodities, and real estate and are known as Sectoral Funds.
Under the tax regime in India, equity funds enjoy certain tax advantages (such as, there is no incidence of long term capital gains tax on equity shares or equity funds which are held for at least 12 months from the date of acquisition). As per current Income Tax rules, an “Equity Oriented Fund” means a Mutual Fund Scheme where the investible funds are invested in equity shares in domestic companies to the extent of more than 65% of the total proceeds of such fund.
An Equity Fund can be actively managed or passively managed.
2.) Debt Funds
Debt funds invest most of their money into debt schemes including corporate debt, debt issued by banks, gilts and government securities. These types of funds are suitable for investors who are not willing to take risks.
Debt funds are ideal for investors who want regular income but are risk averse. Debt funds are less volatile and hence are less risky than equity funds.
If you are investing in traditional fixed income products like fixed deposits then debt mutual funds could be a better option as they provide steady income with low volatility and helps you to achieve your financial goals in a more tax efficient manner.
3.) Balanced funds
Balanced funds invest their money in equity as well as debt.
A balanced fund combines equity stock component, a bond component and sometimes a money market component in a single portfolio. Generally, these hybrid funds stick to a relatively fixed mix of stocks and bonds that reflects either a moderate or higher equity component or conservative or higher fixed-income component orientation.
These funds invest in a mix of equities and debt, giving the investor the best of both worlds. Balanced funds gain from a healthy dose of equities but the debt portion reduces the risk against any downturn.
Balanced funds are suitable for a medium-term horizon and are ideal for investors who are looking for a mixture of safety, income, and modest capital appreciation.
4.) Money Market Mutual Funds
Money market mutual funds are also called Liquid funds. They invest a bulk of their money in safer short-term instruments like Certificates of Deposit, Treasury and Commercial Paper. Most of the investment is for a smaller duration.
The aim of the fund manager of a Liquid Fund is to invest only into liquid investments with good credit rating with a very low possibility of a default. The returns typically take the back seat as protection of capital remains of utmost importance. Control over expenses in the form of the low expense ratio, the good overall credit quality of the portfolio and a disciplined approach to investing are some of the key ingredients of a good liquid fund.
Most retail customers prefer to keep their surplus cash in Savings Bank deposits as they consider the same to be safest and they could withdraw the money at any time. Liquid Funds and Money Market Mutual Funds provide a more attractive option. Surplus cash invested in money market mutual funds earns higher post-tax returns with a reasonable degree of safety of the principal invested and liquidity.
Benefits of Investing In Mutual Funds
1.) Instant diversification
A mutual fund will provide you with a “basket of stocks” from different sectors/same sectors that will provide diversification in your portfolio.
2.) Effective for smaller accounts
Since a mutual fund provides exposure to many stocks, you don’t need to go out and buy many stocks on your own, which could be very prohibitive for you if you have a smaller-sized investment account and limited capital to invest with.
3.) Professional money management
Mutual funds are run by investment managers who would likely be considered “experts” in their field. Mutual funds do not require a great deal of time or knowledge from the investor because they are managed by professional fund managers. This can be a big help to an inexperienced investor who is looking to maximize their financial goals.
liquidity refers to converting your assets to cash with relative ease. Mutual funds are considered liquid assets because the investor can convert the asset into cash by quickly selling it to another on stock exchange/mutual fund companies.
5.) Ease of Comparison
The investor can always compare the returns of the fund with its peer group/benchmark returns. This is because many mutual fund online tools allow the investor to compare the funds based on metrics such as level of risk, return, and price.
A lump sum amount is defined as a single complete sum of money at one go.
2.) Systematic Investment Plan (SIP)
Systematic Investment Plan or SIP is an investment strategy offered by mutual fund houses to investors, making it convenient to invest small sums of money in their mutual fund schemes. The frequency of investment varies from weekly to monthly to quarterly. It is similar to a recurring deposit where you deposit a small /fixed amount every month.
The systematic investment plan or SIP is a convenient way for retail investors to participate in stock market growth. The investor can start the investment from as little as Rs. 500 per month.
3.) Systematic Transfer Plan (STP)
An STP helps you to transfer a fixed amount in a regular interval from a particular mutual fund scheme (usually a debt scheme) to another scheme (usually an equity scheme) within the same fund house. When you are setting up an STP, you are actually instructing the fund house to sell a part of your investment in a mutual fund scheme and invest the money in another scheme. You have to spell out the amount, mutual fund schemes, STP date, frequency, and the investment horizon.