Mutual Fund

 

What are mutual funds?

A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the income it generates.

Why do people buy mutual funds?

Mutual funds are a popular choice among investors because they generally offer the following features:

• Professional Management. The fund managers do the research for you. They select the securities and monitor the performance.
• Diversification or “Don’t put all your eggs in one basket.” Mutual funds typically invest in a range of companies and industries. This helps to lower your risk if one company fails.
• Affordability. Most mutual funds set a relatively low dollar amount for initial investment and subsequent purchases.
• Liquidity. Mutual fund investors can easily redeem their shares at any time, for the current net asset value (NAV) plus any redemption fees.

What are different types of mutual funds?

When you enter a car showroom, you see lots of different cars. There are hatchbacks, sedans, SUVs and maybe even sports cars. Each car in the showroom serves a different purpose. An adventurous person may prefer a sports car while a family man with kids (and a pet) may opt for an SUV. In the same way, there are different types of mutual funds in India.

Each fund type aims to achieve specific goals. Here are the most popular types of mutual funds you can find:

Types of funds based on asset class:

1. 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.
2. 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.
3. 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:

Mutual funds can also be classified basis investment objectives.

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) are an example of tax saving funds.

How to invest in mutual funds:

These days, investing in mutual funds has become effortless. You can even do it right from your home. Here are the steps you can follow to begin your investment journey:

1. Sign up for a mutual fund account
2. Complete your KYC formalities (if you have not yet done so)
3. Enter the necessary details as required
4. Identify the funds you wish to invest based on your financial goals
5. Select the fund and transfer the required amount
6. You can also create a standing instruction with your bank in case you invest in a SIP each month.

What is Systematic Investment Plans (SIP)?

One of the best features about investing in mutual funds is that you don’t need a large amount of money to start investing. Most fund houses in the country allow investors to begin investing with as little as Rs. 500 (some start at Rs. 100) per month through Systematic Investment Plans (SIPs). Now, this might seem like a tiny amount to begin your investment journey, but when you invest consistently over a considerable period, you can achieve a substantial sum.

SIP is a method of investing in mutual funds where you invest a specific amount at fixed intervals. This way, you can avoid timing the market and increase your wealth steadily.

Here’s an example to illustrate the SIP point:

Let’s imagine you invest Rs. 5,000 per month in an equity fund for 12 years. The fund offers an annual return of 15%. At the end of the investment period, you would have amassed a corpus of over Rs. 20 lakh. Now, if you continue investing the same amount for another ten years (total 25 years), you would get a total sum of almost Rs.1.64Crore ! This is roughly four times the amount in an additional ten years.

This is the power of compounding. The returns you earn in turn begin to make profits for you. So, when you invest for a longer time frame, your gains also rise higher. But to gain the maximum benefit of compounding, you should start investing as early as possible and invest for as long as possible. This can give you an extended investment window to increase your returns.

How Mutual funds and investment goals related?

Now that you know the different types of mutual funds, the question arises: ‘Which is the best mutual fund?’

Well, there is no single or right answer to this question. This is because fund houses design mutual funds to achieve specific financial goals. And as an investor, you need to know which mutual funds can help you achieve your goals in the best way possible.

All your investment goals can be categorized into three broad groups:

• Short-term goals (1-3 years): For instance, going on a family vacation in 18 months, buying a car, etc
• Medium-term goals (3-5 years): For instance, doing a short term course in digital marketing in 3/4 years
• Long-term goals (5 years or more): For instance, buying a house in the next 5-7 years

For any goals upto 12 months, it is better to invest in liquid funds since they are less volatile. Liquid funds can be a good option to create an emergency fund. For goals between 1-3 years, you may want to invest in short term debt funds.

Hybrid funds are more suited for medium-term goals since they have the potential to provide both capital appreciation and stability. For long-term purposes, equity funds are suitable.

How to buy and sell mutual funds?

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 fund’s 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. See How to Read a Mutual Fund Prospectus Part 1, Part 2, and Part 3 to learn more about key information in a prospectus.