What is a Mutual Fund?
Mutual funds are the safest way to invest in the stock market and build wealth. As we know, mutual funds are handled by managers who are specialists in the field of investments. Mutual funds can be considered safe as they are supposed to be transparent as per the law, and the documentation is in the public domain with stringent regulator scrutiny.
Investors are invited to purchase units of mutual funds and the money is thus invested to grow. The same money grows if the funds do well and if the funds are not doing well then the invested money can eventually be lost. Hence mutual funds can show movement higher or lower than the purchase price as the value of the asset increases or decreases.
There are many kinds of mutual funds and some are riskier than others and they are accordingly categorized into various types. This article covers all you need to know about mutual funds, their types, why you should invest and how to secure your money.
Save tax
Various tax saving investment options available
Type of Products:
Ranging from debt funds to index funds to ETFs and more
Range of Products:
Invest in more than 60 types of schemes
How Mutual Funds Work
Mutual funds are investments made in various financial assets by professional investment companies on behalf of various investors. These investments are done in bonds, money markets, equities, real estate, and various other securities, with the sole motive to make profits. The term mutual fund is only used in the USA and India, and various other countries use different terms for it.
The value of a mutual fund is in accordance with its net asset value (NAV). The previous day’s NAV is the purchasing price of a mutual fund. This can be calculated by calculating the value of all the assets of the fund and then subtracting the value of liabilities of the fund. The aggregate is divided by the number of units.
Returns are calculated with the help of appreciation in the value of the portfolio. For example, if the mutual fund has invested in stocks and if the value of those stocks increases the value of the mutual fund will also increase.
Types of Mutual Funds
Based on Market Capitalization:
Debt Funds
SEBI defines debt funds on the basis of duration and quality of debt instruments in them.
Hybrid Funds
Hybrid funds are differentiated on the basis of asset allocation by SEBI.
Risks of Investing in Mutual Funds
Mutual funds are not guaranteed investments and fluctuate depending on various reasons. We are now going to discuss the various risks involved in these investments.
Risk of losing money
Mutual funds invest in stocks and the price of some of the stocks may fall bringing the value of those stocks down, but this is easily balanced by other stocks because mutual funds do not invest in just one kind of stock.
Liquidity risk
Equity holders can not sell all their holdings of a particular stock at one go as there are restrictions on that, hence the problem of liquidity.
Risk due to interest rate
When there are securities in the portfolio of a mutual fund, especially fixed-income securities. When interest rates rise, prices of fixed-income securities fall and when interest rates drop, prices increase. But securities are just a portion of the total portfolio and the other investments balance the overall price, it will only be a problem if a significant portion of the corpus is invested in it.
Risk due to default
In the case of investment in corporate bonds, there is a chance of default and the bonds may become a bad investment bridging down the value of the portfolio. This problem is more evident in bonds issued by private players and government bonds of a stable economy are considered to be safe. To bring an end to this issue there are rating agencies that rate companies in accordance with their overall credibility and accordingly investments are made.
Interest rate
If there is any fluctuation in the interest rate, if the interest rate is the floating rate of interest the prices of the bond in a portfolio fluctuate.
Advantages of Investing in Mutual Funds
There are many advantages of investing in mutual funds especially for beginners and people with less capital, which can not be compared to any other kind of investment, we are going to discuss them one by one:
Funds are managed by professionals
Mutual fund managers are thoroughly trained professionals with years of experience, at the same time they are concerned about their professional reputation and accordingly are better equipped to understand and analyze the markets than a lay investor. Hence chances of losing money are very little.
Mutual funds are extremely affordable
Mutual funds are quite affordable as one can even start the investment with INR 100. Hence, there is no need to necessarily invest only when you have huge sums of money. You can instead start small and build as deemed fit.
Minimal risk
Mutual funds have an extremely diversified portfolio and this reduces the risk to a great extent. If a person has invested in just one company, two or three, then the chances of losing the money are much higher than in a mutual fund which has invested in a number of instruments. These investments are done in various segments like banking, infrastructure, real estate, and equities.
The number of companies a mutual fund invests in can be numerous, 25, to 50, or can be more, but a single investor has their limit set.
Under government regulations
SEBI (The Securities and Exchange Board of India) under the ownership of the Ministry of Finance (Government of India) is the regulator of mutual funds and keeps a very close eye on their functioning ensuring any malpractice is not spared and hence, making these investments extra safe.
Liquidity
Investors can very easily liquidate their mutual fund units if they require liquid cash.
Tax benefits
There are tax benefits if a person has invested in tax-saving mutual funds also called ELSS funds for up to a sum of INR 1,50,000 under Section 80C of the Income Tax Act, 1961. This amount is the maximum benefit one can avail for a financial year.
How to Buy Mutual Funds?
Investors can invest in mutual funds by starting a SIP or by investing in lump sum:
SIP
You can start investing a fixed amount of money at regular intervals, online or offline.
Lump Sum
Here you can invest a chunk of money in just one go, online or offline.
One can invest in the following manner:
Online
Investors will have to open an online account with the asset management company. This can be done directly with a mutual fund company or another service provider. Here you will go through the KYC checks and attach your bank account with this particular account. You will have to activate the facility of auto-debit if you want to go for a SIP.
Offline
You will have to visit the office of the mutual fund company and go through the KYC procedures and manually fill out a form for the mutual fund. Another form will have to be deposited at your bank to inform them about the auto-debit in case of a SIP. In case of a lump sum investment, you will have to provide the company with a cheque for the total investment amount.
The disadvantage of this method is that a mutual fund company may not have its office in your vicinity, and if you invest with the help of a middleman a handsome amount of commission is deducted from the invested sum.
Save tax
Various tax saving investment options available
Type of Products:
Ranging from debt funds to index funds to ETFs and more
Range of Products:
Invest in more than 60 types of schemes
How to Sell Mutual Funds
There are again two ways of redeeming a mutual fund, one is online and the other is offline.
Online
Investors can redeem their mutual fund using the online portal from where it has been purchased. They can sell some units or all, depending on them. The request is processed and the amount is sent via NEFT to the bank account of the investor.
Offline
Investors can redeem units by visiting the office of the mutual fund company physically. This method is slow and takes time.
Once the redemption is processed, investors will receive the redemption amount via NEFT or through a cheque sent to the registered address
FAQs
Are mutual funds a safe investment?
Mutual funds are stable as they are diversified and safe as there are ample government checks to safeguard investors from any malpractices. Today they function in a very transparent manner adding to the credibility.
Can mutual fund shares be sold at any time?
Yes, any time, and the whole procedure is discussed above. The only thing to be taken into consideration is the NAV (Net Asset Value) of the previous day. If the NAV is below what you purchased then it will be a loss for the investor, the higher the NAV from the purchasing price more the profit, the theory has been discussed at length above.
What is a target date mutual fund?
These mutual funds are designed to maximize profits by a particular date. They have a very different way of investing than other mutual funds, they invest in more radical small-cap mutual funds or any fund which can grow rapidly and maximize the profits and as the due date approaches they withdraw from these stocks and invest the money made in more stable and conservative stocks.
What are systematic investment plans (SIP)?
A SIP is a systematic investment plan, which is a method of investing in mutual funds that allow investors to park their capital in a fixed unit-based manner on a periodic basis. Investing in SIPs implies the investor is investing in a mutual fund with the only difference being that SIPs are meant to set a periodic structure to the investment instead of it being done in a lump sum.
Similar to the above, there are numerous differences that are detailed in this guide by Forbes Advisor India: “Stocks Vs Mutual Funds: What’s The Difference`?”.
Why do people buy mutual funds?
Mutual funds are the most hassle-free way of investing in the market, as these funds are managed by professionals the chances to lose money are minimal. The government keeps an eye on the functioning of these funds making them even more secure to enable one and all to invest in the market on their own.
