Mutual Funds
What is a Mutual Fund?
To many people, Mutual Funds can seem complicated or intimidating. We are going to try and simplify it for you at its very basic level.
Essentially, the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund.
This fund is managed by a professional fund manager.
It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities.
Each investor owns units, which represent a portion of the holdings of the fund.
The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV”.
Simply put, a Mutual Fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
Types of Mutual Fund?
Various types of Mutual Fund schemes exist to cater to different needs of different people.
Largely there are three types mutual funds.
Equity or Growth Funds
-These invest predominantly in equities i.e. shares of companies
-The primary objective is wealth creation or capital appreciation.
-They have the potential to generate higher return and are best for long term investments.
-Examples would be
- “Large Cap” funds which invest predominantly in companies that run large established business
- “Mid Cap Funds” which invest in mid-sized companies. funds which invest in mid-sized companies.
- “Small Cap” funds that invest in small sized companies
- “Multi Cap” funds that invest in a mix of large, mid and small sized companies.
- “Sector funds” that invest in companies that are related to one type of business. For e.g. Technology funds that invest only in technology companies
- “Thematic funds” that invest in a common theme. For e.g. Infrastructure funds that invest in companies that will benefit from the growth in the infrastructure segment
- Tax-Saving Funds
Income or Bond or Fixed Income Funds
-These invest in Fixed Income Securities, like
- Government Securities or Bonds,
- Commercial Papers and Debentures,
- Bank Certificates of Deposits and
- Money Market instruments like Treasury Bills, Commercial Paper, etc.
-These are relatively safer investments and are suitable for Income Generation.
-Examples would be
Hybrid Fund
-These invest in both Equities and Fixed Income, thus offering the best of both, Growth Potential as well as Income Generation.
-Examples would be
- Aggressive Balanced Funds,
- Conservative Balanced Funds,
- Pension Plans,
- Child Plans and
- Monthly Income Plans, etc.
Other types
- Index Funds
- International Funds
Benefits of Investing in Mutual Funds?
We’ve read about what mutual funds are and types of it, now we are going to understand the benefits of investing in mutual funds.
Mutual funds are often misunderstood as a very complex investment vehicle but in reality they are pretty simple in their investment philosophy and offer investors many benefits like professional money management, diversification, liquidity, transparency to name a few.
For most retail investors it becomes quite challenging to manage their money on their own and the task of analysing various companies and investing individually in them.
Mutual fund is a very suitable investment vehicle for retail investors because of the benefits it provides to them. Some of the benefits of investing in mutual funds are explained below:
1. Professional Management:
One of the most important benefit of investing in mutual fund is the professional management of funds by qualified and experts that are backed by a dedicated research team which analysis the performance and future prospects of companies and selects suitable investments.
Most of the retail investors do not have the required time and resources to conduct the research and buy stocks of different companies individually. And that’s why it becomes very helpful for them to use mutual funds to invest in market which are managed by professional fund managers.
2.Diversification:
Mutual Funds invest the money collected from all investors into multiple asset classes based on the objective of different schemes.
In equity segment also, money is diversified in different companies of multiple sectors and different companies of a particular sector as per the objective of the fund and this reduces the risk of investing in a particular company stock.
In mutual funds, money is invested in a mixture of assets according to one’s risk appetite. For example, an equity oriented fund would generally comprise of 60-70% investments in equities and remaining 30-40% in debt securities.
Diversification helps reducing the risk associated with different asset classes. With diversification, the risk associated with one asset class is countered by the others. This way, you don’t lose out on the entire value of your investment if a particular compenent of your portfolio goes through a bad period.
3.Liquidity
In mutual funds, investors can redeem the units at any point in time.
Investors can easily sell the units of mutual funds and receive the current value of units at prevailing Net Asset Value in their bank account in few days.
You can easily redeem the units of open ended mutual fund schemes to meet your financial needs on any business day (when the stock markets and/or banks are open), so you have easy access to your money.
Upon redemption, the redemption amount is credited in your bank account within one day to 3-4 days, depending upon the type of scheme e.g., in respect of Liquid Funds and Overnight Funds, the redemption amount is paid out the next business day.
4.Tax-benefits
Mutual funds provide the best tax saving option in the name of Equity Linked Savings Schemes(ELSS).
By investing in a ELSS mutual fund scheme you can have a tax exemption of Rs.1,50,000 in a year in Section 80C of Income Tax Act.
Mutual funds investments when held for a long period are tax efficient as compared to other savings instruments like PPF, NPS and tax saving FDs.
Investment in ELSS mutual fund schemes helps investors to save tax for a particular year and also helps in your wealth creation journey as money gets invested in equities.
5.Low Cost
An important benefit of investing in mutual funds is their low cost.
Due to huge economies of scale, mutual fund schemes have a low expense ratio.
Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund’s daily net assets. Operating expenses of a scheme are administration, management, advertising related expenses, etc.
The limits of expense ratio for various types of schemes has been specified under Regulation 52 of SEBI Mutual Fund Regulations, 1996.
In a mutual fund, funds are collected from large number of investors and the same are used for purchasing the securities for investment.
These funds are however invested in assets which therefore helps one save on transaction and other costs as compared to a single transaction.
6.Well Regulated
Mutual Funds are regulated by the capital markets regulator, SEBI(Securities and Exchange Board of India) under SEBI (Mutual Funds) Regulations, 1996.
SEBI has framed regulatory provisions to protect the interest of investors.
The operations of mutual funds are regularly monitered by SEBI.
Moreover, all mutual funds are required to disclose their portfolios every month to SEBI.
7.Easily Accessible
Mutual funds are easily accessible and you can buy it from anywhere in the world.
An Asset Management Company(AMC) distributes mutual funds through many channels like:
Agents and Banks
Brokerage Firms
AMC themselves
Registrars like CAMS and Karvy
Online investment platforms
Also you don’t require a demat account to invest in mutual funds.