What exactly is Mutual Fund ? Traditionally, Indians have invested in real estate, gold, and bank fixed deposits. But in the last 20 years, mutual funds have become an alternative and possibly better way to invest.
What do mutual funds do?
Mutual funds invest investor funds in stocks, bonds, government securities, gold, and other assets. Companies create Asset Management Companies (AMCs) or Fund Houses to pool investor funds, market mutual funds, manage investments, and allow investors to buy and sell shares.
Mutual funds are run by fund managers, who are good with money and know how to analyze and manage investments. Mutual funds collect money from investors and put it into stocks, bonds, and other financial assets, depending on the fund’s investment goal.
In India, the Securities and Exchange Board of India (SEBI), which is in charge of the capital markets, has helped the mutual fund industry by setting up a system that works for everyone, including investors and mutual fund sponsors.
How do shared funds work?
To understand mutual funds, we must first understand NAV (Net Asset Value). Mutual fund investors buy and sell at Net Asset Value (NAV) per unit. Investors in mutual funds receive the same number of units as their investments. Based on NAV. A mutual fund with a NAV of Rs 10 will give you 50 units if you invest Rs 500.
Based on the mutual fund’s assets, the NAV changes daily. If a stock rises tomorrow, a mutual fund’s NAV will rise. If the mutual fund’s NAV rises to Rs 20, your 50 units are worth Rs 1000 instead of Rs 500. 500 x Rs 20. Thus, investors’ returns are based on the mutual fund’s underlying assets.
Redeem your mutual fund units for Rs 1000 instead of Rs 500. Capital gain is Rs 500. Mutual fund portfolios fluctuate daily.
Fund portfolio valuation affects NAV daily. The NAV and underlying assets can turn this Rs 500 gain into a loss. Mutual fund returns vary and are market-related.
Classification based on the structure:
Open-ended funds are mutual funds that allow you to invest and get your money back at any time. This means that they are always available. They are easy to get and don’t have a set time for investing.
Closed-ended schemes have a fixed end date. You can only invest in a new fund’s offer and get your money back when it matures. Close-ended mutual funds don’t allow on-demand purchases.
Classification based on asset classes:
Equity mutual funds invest 65% in publicly traded companies. Stocks are better long-term investments (> 5 years) due to their volatility. They’re risky but could pay off. Equity mutual funds include:
Large-cap funds invest at least 80% of their assets in AMFI’s top 100 market-capitalized stocks.AMFI represents mutual funds.
It protects and promotes mutual funds and unitholders.Mid-cap funds invest at least 65% of their funds in mid-cap companies (101st–250th in market capitalization)
Also Read: How Does The Stock Market Pay Off?
Multi-cap Funds:
These funds invest in stocks of companies of all market capitalizations, including large-cap, mid-cap, and small-cap stocks. At the level of market capitalization, SEBI has not set a limit on the amount of money that can be invested.
Debt mutual funds typically invest in government securities, corporate bonds, and other debt instruments.
Glit Funds invest at least 80% in Treasury securities with various maturities. Government securities are better long-term investments due to their short-term volatility.
This investing method teaches discipline and eliminates the need to time investments. Many investors attempt market timing, which takes time and skill. SIPs spread out costs and don’t require market timing. Units are higher when NAV is low and vice versa. SIPs can build your mutual fund investment corpus over time.
Mutual funds set the minimum amounts for lump sum and SIP investments, which can start as low as Rs 500.
Benefits of Investing in Mutual Funds
Diversification:
Direct equity investing buys individual company stocks, while equity mutual funds buy a basket of stocks from different sectors, reducing risk.
Professional management
Mutual funds are managed by full-time, professional fund managers who have the knowledge, experience, and resources to actively buy, sell, and manage investments. A fund manager keeps an eye on the investments and rebalances the portfolio as needed to meet the scheme’s goals.
Transparency
Every mutual fund has a Scheme Information Document that is easily accessible on the website of the fund house. This document can tell you everything you need to know about the fund’s holdings, fund manager, etc.
Liquidity
You can cash out your investments on any business day at the NAV of the day you cash them out. So, depending on the type of mutual fund you invested in, the money you invested would be in your bank account in 1–3 days.
Tax savings
If you invest up to Rs. 1,50,000 in ELSS mutual funds, you can get a tax break under section 80C of the Income Tax Act, 1961.
Choice
There are many ways to invest in mutual funds to meet your different needs. Liquid funds, for example, are for investors who want to benefit from the safety of debt and low interest rate risk.
Cost-effective
A mutual fund is a low-cost way to invest. Mutual fund investments are pooled. The fund can invest in a basket of stocks and debt securities that are out of reach for the average investor or require a higher investment amount. These investments use scale.
Returns
Mutual fund returns are not guaranteed and are subject to market risks. But over the long term, equity mutual funds have the potential to give yearly returns of more than 10%.
Drawbacks of mutual funds
Exit Load:
Mutual funds usually charge an exit load (fee) for cashing out investments within a certain amount of time, like one year from the date of investment. This prevents investors from leaving the scheme early, which would hurt the fund’s performance and goals.
High costs (in some mutual funds):
SEBI has set the maximum expense ratios that mutual funds can charge, and they depend on how big the mutual fund is. As the size grows, the cost tends to go down. The highest expense ratio that can be charged by an equity-focused mutual fund is 2.25%.
Overdiversification
Investments in mutual funds are subject to market risk. Diversification can’t lower the risk of loss in the financial markets for any type of security. Equity mutual funds face stock market volatility risk. Debt mutual funds face interest rate risk
Final Thoughts
Indian investors can grow their money faster with mutual funds. They can provide higher returns, capital growth, income, inflation protection, and money for long-term and short-term needs.
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