What are Mutual Funds?
Mutual fund is a company that consolidates small amounts of money from many investors and invests the money in various financial instruments such as stocks, bonds, and short-term debt. The combined holding of a mutual fund is usually known as its portfolio. Investors can trade in mutual funds the same way they buy shares. Each share they purchase represents a investor’s ownership in the fund and the income it generates.
Thus it is an investment vehicle where many investors pool their money to earn returns on their capital over a period. This corpus of funds is managed by an investment professional known as a fund manager or portfolio manager. It is his/her job to invest the corpus in different securities such as bonds, stocks, gold and other assets and seek to provide potential returns. The gains (or losses) on the investment are shared collectively by the investors in proportion to their contribution to the fund.
Types of Funds Based on Asset Class
Debt funds-
Debt funds (also known as fixed income funds) invest in assets like government securities and corporate bonds. These funds aim to offer reasonable returns to the investor and are considered relatively less risky. These funds are ideal if you aim for a steady income and are averse to risk.
Equity funds-
In contrast to debt funds, equity funds invest your money in stocks. Capital appreciation is an important objective for these funds. But since the returns on equity funds are linked to market movements of stocks, these funds have a higher degree of risk. They are a good choice if you want to invest for long term goals such as retirement planning or buying a house as the level of risk comes down over time.
Hybrid funds-
What if you want equity as well as debt in your investment? Well, hybrid funds are the answer. Hybrid funds invest in a mix of both equity and fixed income securities. Based on the allocation between equity and debt (asset allocation), hybrid funds are further classified into various sub-categories.
Types of Funds Based on Investment Objective:
Growth funds- The main objective of growth funds is capital appreciation. These funds put a significant portion of the money in stocks. These funds can be relatively more risky due to high exposure to equity and hence it is good to invest in them for the long-term. But if you are nearing your goal, for example, you may want to avoid these funds.
Income funds- As the name suggests, income funds try to provide investors with a stable income. These are debt funds that invest mostly in bonds, government securities and certificate of deposits, etc. They are suitable for different -term goals and for investors with a lower-risk appetite.
Liquid funds- Liquid funds put money in short-term money market instruments like treasury bills, Certificate of Deposits (CDs), term deposits, commercial papers and so on. Liquid funds help to park your surplus money for a few days to a few months or create an emergency fund.
Tax saving funds- Tax saving funds offer you tax benefits under Section 80C of the Income Tax Act. When you invest in these funds, you can claim deductions up to Rs 1.5 lakh each year. Equity Linked Saving Scheme (ELSS) is an example of tax saving funds.
Types Funds Based on Structure:
Open-ended mutual funds- Open-ended funds are mutual funds where an investor can invest on any business day. These funds are bought and sold at their net asset value (NAV). Open-ended funds are highly liquid because you can redeem your units from the fund on any business day at your convenience.
Close-ended mutual funds- Close-ended funds come with a pre-defined maturity period. Investors can invest in the fund only when it is launched and can withdraw their money from the fund only at the time of maturity. These funds are listed just like shares in the stock market. However, they are not very liquid because trading volumes are very less.
Benefits In Investing Mutual Funds
- Diversification
We may have heard the saying; “don’t put all your eggs in one basket”. This is a famous mantra to remember when you invest your money. When we invest only in a single asset, we could risk a loss if the market crashes. So we can avoid this problem by investing in different asset classes and diversifying portfolio.
- Tax benefits
Mutual fund investors claim a tax deduction of up to Rs. 1.5 lakh by investing in equity linked saving schemes (ELSS). This tax benefit is eligible under section 80C of the income tax act. ELSS funds come with lock-in period of 3 years. (We can discuss lock0in period in next point) hence, if we invest in ELSS funds, you can only withdraw money after the lock-in period over. Other tax benefit is indexation benefit available on debt funds. In case of traditional products, all interest earned is subject to tax.
- Returns
one of the biggest mutual fund benefits is that have the opportunity to earn potentially higher returns than traditional investment options offering assured returns. This is because the return on mutual funds is linked to the market performance. So, if the market is on a bull run and it does exceedingly well, the impact would be reflected in the value of your fund. So, poor performance in the market could negatively impact your investments.
- Professional expertise
Mutual funds are actively managed by a professional who constantly monitors the fund’s portfolio. In addition, the manager can devote more time selecting investments than a retail investor would.
How to Invest
Investors buy mutual fund shares from the fund itself or through a broker for the fund, rather than from other investors. The price that investors pay for the mutual fund is the funds per share net asset value plus any fees charged at the time of purchase, such as sales loads.
Mutual fund shares are “redeemable,” meaning investors can sell the shares back to the fund at any time. The fund usually must send you the payment within seven days.
Before buying shares in a mutual fund, read the prospectus carefully. The prospectus contains information about the mutual fund’s investment objectives, risks, performance, and expenses.
To Conclude:
Investing in mutual funds is one of the simplest ways to achieve your financial goals on time. But before you invest, take an adequate amount of time to go through the different fund options. Don’t invest in a fund because your colleague or friend has invested in it. Identify your goals and invest accordingly. If required, you can approach a financial advisor to help you make the right investment decisions and plan your financial journey.
Note: SIP should not be construed as promise on minimum returns and/or safeguard of capital. SIP does not assure any protection against losses in declining market conditions.
