A Guide to Mutual Funds

Nowadays, mutual funds are a trending topic, you might have heard about it. So, today we are going to discuss mutual funds, types of mutual funds, how it works and the advantages of mutual funds. If you are looking to invest in mutual funds then this article will help you to understand and to choose which is the right mutual fund for your investment. 

What is a Mutual Fund?

A Mutual fund is a common pool of money that is collected from a large number of investors who have the same investment objective. Then, the collected funds are invested in securities such as stocks, money market instruments, bonds, other securities, or assets. Mutual funds are operated by Fund managers. Where and how much to invest the collected funds, all the decisions are taken by the Fund Manager to get maximum return. Mutual funds charge less than the hedge fund, both the mutual fund and hedge fund manage the portfolios that are created from pooled funds. The hedge fund managers earn higher and it offers investment privately. Fee of the hedge fund managers is more and it has higher risk than the regular mutual fund. That’s why the mutual fund is more convenient than the other.

Benefits of Investing in Mutual Funds

It is becoming more popular because it is provide several advantages  are as follows:

Diversification 

Diversification is a dominant way of reducing risk. It allows investors to make a diversified portfolio in a cost-effective and easier way. Whenever you invest in a mutual fund scheme, your money is invested, not only in companies across sectors and industries but also across asset classes like equity, debt, etc. The reason for doing this is to reduce the risk because not at the same time asset classes fail.

Professional Management

One of the significant advantages of mutual funds is that your money is managed by experts. An experienced fund manager and their team continuously monitor various securities and according to the changing market condition, it keeps optimizing your portfolio from which you get the best possible returns on your investments.   

Liquidity

Investment can be withdrawn when needed. Mutual funds do not have any lock-in period which means that you can redeem your investments whenever you need money. The request for redemption can be placed in just a few clicks and the request is quickly processed as compared to other investment options. After that, AMC(asset management company) will credit your money in your bank account within 3-7 business days. You may don’t get the same flexibility when it comes to other investments. 

Regulations

In India, SEBI(Securities and Exchange Board of India) regulates the mutual fund industry. SEBI is a government agency that supervises the investor’s investments. 

Low Cost

An investor may want to invest in big companies or to purchase the shares of big companies and if the investors do not have that much money to make a big investment then through a Systematic Investment Plan(SIP) anyone can start investing with as little as Rs 500. Mutual funds are cheaper and thereby, they are suitable for small investors. And in the case of a lump sum, the minimum investment amount varies between Rs 1,000- Rs 5,000 in case of lump-sum investing. 

Flexibility

Another benefit of investing in mutual funds is that they can always remain accessible to you. Investors can enter and exit mutual funds at any time, unlike other investment options. And this is the reason that investors prefer mutual funds over any other investment option.

Variety and Freedom of Choice

Another benefit of investing in mutual funds is, whatever your investment goal, the time frame of your investments, and risk appetite. You will find a scheme that suits your needs. Mutual funds are absolutely perfect for your different investment objectives from high-risk, high-reward equity funds to low-risk debt funds.

Transparency

As earlier said, mutual funds are regulated by SEBI(Securities and Exchange Board of India). In a mutual fund, SEBI has been protecting the investors interest and it also ensures the best practices by Asset management companies. Investor’s are aware all the time of where his/her money is being invested. 

Easy to Tracking

Tracking the investment in mutual funds is easy. The Asset Management Company understands that it is difficult for investors to track their investment from their busy schedule so they provide the regular statement of their investment so that they can track their finances.

Returns

Mutual funds provide a better return as compared to other investment options because equity funds invest your money in companies that are driving India forward. And you directly get the benefit from the growth of these companies.

Types of Mutual Funds

Mutual funds are divided into various kinds of categories. 

Based on Structure

 

Open-Ended Funds: In this scheme, investors can buy or sell their units from AMC at any time. Open-ended funds do not have a fixed maturity date. The investors have the flexibility to sell or buy their units at current net asset value(NAV). 

Closed-Ended Funds: In closed-ended schemes, the investors can not sell or buy their unit of the closed-ended fund after the NFO(New Fund Offer)is over. Once the offer closes, no new investments can be permitted. As per the SEBI regulation, all closed-ended funds need to be listed in the stock exchange. The closed-ended scheme has a fixed maturity date. You might have heard of another term called private equity fund, these funds are closed-ended funds that are not listed on public exchange. But the only difference between public and private mutual funds is that, public equity means the ownership of shares in the public company while the private equity fund means the ownership of shares in private companies.

Interval Funds : Internal funds come in between open-ended and closed-ended funds, sometimes interval funds behave as an open-ended scheme and, sometimes, it behaves as a closed-ended scheme. In an interval fund, investors can buy or sell their unit during a predefined interval, this time period is decided by the fund house.

Based on Asset Classes

The categories of mutual funds based on asset classes are in detail below:

Equity Funds

Equity mutual funds are best suited for those investors who have a long-term investment horizon. An equity fund is a fund that is invested in the stock market. It has comparatively high risk but equity funds provide potentially high returns among all classes of mutual fund.

The equity funds are further classified as below:

1. Small-Cap Funds: Small-cap funds invest in stocks of 251st and beyond companies according to the market capitalization. It invests around 65% of its total assets in equity shares of small-cap companies. Small-cap funds offer great returns as compared to the large-cap and mid-cap schemes but it is most volatile. 

2. Mid-Cap Funds: Mid-cap invest in stocks of 101-250 th companies in accordance with market capitalization. It invests around 65% of their total assets in equity shares of mid-cap companies. Mid-cap offers better returns than large-cap schemes. It is usually more volatile than large-cap funds.

3. Large-Cap Funds: Large-cap funds invest a minimum of 80% of their total asset in equity of large-cap companies. Large-cap funds are ranked between 1 to 100 in market capitalization.

4. Multi-Cap Funds: It invests a minimum of 65% in equity & equity-related instruments. Multi-cap schemes will invest across large cap, mid cap, small-cap stocks. The fund manager keeps changing the asset allocation depending on the market and economic condition.

5. Sector or Thematic Funds: These funds invest in particular sectors/ particular themes with 80% of the portfolio in such sectors/ themes. Sector or Thematic Fund can be done by well- performed investors as they have very high risk.

6. Index Funds: It is a type of equity fund which has the intention of tracking and imitating the performance of the popular stock market index like NSE Nifty, BSE Sensex, etc. In index funds, the asset allocation and the offers returned are similar to that of its underlying index. 

7. ELSS: ELSS stands for Equity Linked Savings Scheme. ELSS schemes will invest a minimum 80% of their total asset in equity and equity-related instruments and it offers tax benefits up to Rs 1,50,000 a year under Section 80C of the Income Tax Act.

Debt Mutual Funds

Debt Mutual Funds is a kind of mutual fund that invests in fixed income securities like Bonds, corporate debentures, money market instruments, and Government securities. The objective of Debt mutual funds is to provide regular and steady income to investors and it is perfect for low-to-moderate risk profile investors. The debt fund is best for those investors who have short-term investment goals. It is less risky than equity schemes and the potential of return is lower as well.

There are various ways of categorizing debt mutual funds. The categories are as follows:

1. Dynamic Bond Funds: It is a type of debt mutual fund whose portfolio is actively managed and modified depending on the fluctuation in the interest rates which is viewed by the fund managers.

2. Income Funds: Income Funds invest in securities that have a  long maturity period and provide stable returns over time. The average maturity period of income funds is five years.

3. Short-Term and Ultra Short-Term Debt Funds: These mutual funds invest in securities that mature in one to three years. 

4. Liquid Funds: Liquid funds invest in very short-term debt and market instruments which have a maximum maturity period of upto 91 days. Liquid funds normally invest in high-rated instruments. 

5. Gilt Funds: A debt scheme that invests atleast 80% of their assets in high-rated government securities across maturity. And it is very safe. The gilt fund invests only in high quality and low risk.

6. Credit Opportunities Funds: It invests mostly in low-rated securities that have the potential to offer higher returns, these credit opportunity funds are the riskiest among all the classes of debt funds.

7. Fixed Maturity Plans: It is closed-ended funds that come with a fixed maturity date. Fixed maturity plans or FMPs invest in fixed maturity instruments like government bonds. It can only be bought during their NFO(New Fund Offer) and the investment will be locked in for a predefined period.

Hybrid Mutual Funds

Hybrid mutual funds invest across both equity mutual funds and debt mutual funds The volatility of the hybrid mutual funds lies in between equity mutual funds and debt mutual funds. To benefit the investors and reduce the risk levels, the fund manager modifies the asset allocation of the fund depending on the market condition. It offers an excellent way of diversifying the investor’s portfolio.

Hybrid mutual fund categories:

1. Equity-Oriented Hybrid Funds: When the fund manager invests atleast 65% of the fund’s asset in equity mutual fund and the rest in debt mutual fund and money market instruments then it is known as an equity-oriented fund. In equity-oriented hybrid funds, the equity components include equity shares of companies across industries like healthcare, real estate, finance, automobile, and many more.

2. Debt-Oriented Hybrid Funds: It allocates at least 65% of its portfolio in fixed-income instruments like government securities, treasury bills, and the remaining is invested in equities.

3. Monthly Income Plans: It is also known as MIPs that invest in debt instruments in which the equity exposure is limited to under 20%. The aim of monthly income plans is to give a steady return over time. It totally depends on the investors to receive dividends on a monthly, quarterly, or annual basis. 

4. Arbitrage Funds: The aim of arbitrage funds is to maximize the returns by buying securities in one market at a low price and sell them in another market at a premium. Arbitrage funds are hybrid in nature.

Based on investment style

1. Active: In these actively managed funds, the fund manager actively manages the portfolio in which they make decisions on which stock to purchase, when to buy and sell it.The aim of actively managed funds is to beat the benchmark. The expense ratio of actively managed mutual funds is higher as compared to the  passively managed mutual funds.

2. Passive: In passively managed funds, replication of the index with exactly the same stock and in the same proportion is done by fund managers. It does not take active investment decisions and has a lower expense ratio. The aim of passively managed funds is to provide only market returns and not beat them. 

How Does a Mutual Fund Work?

Mutual funds collect money from investors and allot them units. The price of each mutual fund unit is called the Net Asset Value(NAV).  Allotted units represent the money invested in the mutual fund. These units are easily and quickly redeemable to retake your money whenever you need it. All the collected money is invested into different investment opportunities, depending on the objective of the mutual fund scheme. The fund managers do not invest the whole corpus in one stock. They diversified the collected corpus in different stocks, the reason behind this is to reduce the risk. In this way, the loss of one stock can be balanced with the profit to get in another. Mutual funds will earn and come out of that and then earned money comes in the form of interest or it can be in the form of dividends.

Let’s take a simple example, assume they have got Rs 200 then what the mutual fund is going to do is distribute this to the investors who are invested in the mutual fund. Keep in mind that they do not distribute the entire 200 Rupees, they take out some portion of it for their own purpose which is known as the expense ratio. The expense ratio could be 1% to 3% of the total investment amount.

In a mutual fund, all profits, losses are shared by all the investors who are invested in the mutual fund. The best thing about mutual funds is no matter how big or small your goal is, you can achieve it by investing in Mutual Funds. 

Frequently Asked Questions

Who Should Invest in Mutual Funds?

Everyone who has a financial goal whether short-term or long-term, so they can invest in a mutual fund. Some Asset Management Companies do not accept investments from NRI’s. It is an excellent way to achieve your financial goal but before starting investing in a mutual fund just find your risk profile, financial goal, and investment horizon. 

When Should You Invest in Mutual Funds?

If you want to invest in a mutual fund, you don’t need to wait for a time to invest which means you can invest any time. The fund managers and their team monitor and choose only the right securities and assets to provide the benefits to the investors like you and me hence, you need not wait for any time to invest in mutual funds. 

Are mutual funds safe?

It is absolutely safe to invest in a mutual fund. Because all the fund plans and fund houses have comes under the SEBI(Securities and Exchange Board of India), Reserve Bank of India(RBI), and AMFI(Association of Mutual Funds in India). 

What is the Expense ratio?

It is also known as management expenses. The expense ratio is a fee charged by the fund house for managing the investments of the investors. This charge you will be paying on an annual basis. The expense ratio is less than 2.5% of the amount which is invested by the investors. This expense ratio is used to provide the fund manager’s salary and other fund expenses.  

What is Exit load?

Exit load is the penalty charged by the fund houses when investors choose to exit or leave a scheme before a specific period of time. Investors need to read the fund offer carefully before investing because most of the mutual funds are open-ended which have no exit load. As the equity funds have upto 1 year of exit load, the liquid fund has 7 days.

Can mutual funds be sold anytime?

Open-ended mutual funds can be sold or bought anytime but close-ended funds can only be redeemed during the maturity period . We recommend you to invest in open-ended. 

How to choose a suitable mutual fund?

Before starting investing in a mutual fund first, decide the risk you can take and the investment horizon. It will help to choose the right mutual fund and check if the fund’s investment objective matches your financial goals or not. Select the fund from the categories that will give you good returns.

What are Direct and Regular Mutual funds? 

The direct fund is a type of fund that investors do not buy from distributors but they are bought directly from Asset Management Companies. The benefit of the direct Plan is it has a lower expense ratio than the regular plan. All the transactions will happen online or physically by visiting the Asset Management Company. In Direct Plan investors need to do their own research on mutual funds to invest. The distributor helps in selling mutual funds schemes and even servicing you they earn a commission. By visiting an Asset Management Company no commissions are paid there. There are various platforms through which investors can buy direct plans of mutual funds.

The regular plan is when investors use the services of a distributor or an agent, the regular plan has a higher expense ratio as compared to the direct plan and will generate lower returns. While in the regular plan, the commission is paid by the fund house on the money you invest in the regular plan. 

Can I get monthly income from mutual funds?

Yes, you can get the monthly income from the mutual funds by the dividend option. You can earn monthly dividends. But it is not compulsory for a fund to pay dividends before investing, you need to be careful and you must not invest in a poor-quality fund just because they provide dividends.

Can investors lose money in mutual funds? 

Yes, investors can lose money in mutual funds because they are linked to the market. The values will fluctuate daily. The best way to minimize your loss is to invest in the best mutual funds only. 

What is NAV?

The full form of NAV is Net Asset Value, it represents the cost price of each unit of mutual fund which can be increased or decreased as per the market fluctuations. NAV is calculated by-

The net value of asset = (Total asset – total liabilities)/ total outstanding shares.

What is SIP(Systematic Investment Plan )?

The most important advantage of investing in mutual funds is, the investors can invest a small amount via a systematic investment plan. It is a way of investing in mutual funds at the regular interval

Systematic Investment Plan (SIP) is a way of investing money in mutual funds in a regular manner. It allows investors to initiate or terminate a Systematic investment plan when they need it. SIP’s frequencies can be monthly, quarterly, bi-annually, and or as per investor’s comfort.