What are Mutual Funds in simple words: how mutual funds work is essential to making informed investment decisions. Mutual funds offer a range of benefits such as diversification, professional fund management, liquidity, Wealth Creation and more.
Thats the reason, mutual funds are highly preferable investment avenue which can help you reach your financial objectives.
Mutual funds provide access to a diversified portfolio of stocks, bonds, and other securities. This diversification spreads the risk, making mutual funds a smart choice for long-term investment growth.
Table of Contents
What is Mutual Fund in simple words?
A Mutual Fund is an investment scheme where people pool money (just like other investments). This money is invested (on your behalf) in stocks, bonds or other securities ( depending on the scheme’s objective).
These funds are managed by professional fund managers who aim to generate returns for investors
These investments can be used for various investment requirements such as financial goals ( retirement, child education, purchase of assets, home, etc.), short-term money parking, fixed maturity plans, regular income, tax saving and wealth creation.
There are numerous benefits of investing in mutual funds, like flexibility to choose your investment, low investment amount etc. (we will discuss it later in the post).
Types of Mutual Funds in India
Mutual funds in India are categorised based on various factors:
By Asset Class:
- Equity Funds: Invest primarily in stocks, suitable for long-term growth.
- Debt Funds: Invest in fixed-income securities, offering regular income.
- Hybrid Funds( balanced): Combine equities and debts to balance risk and return.
By Structure:
- Open-Ended Funds: Allow investors to enter and exit at any time.
- Closed-Ended Funds: Have a fixed maturity period and are traded on stock exchanges.
By Investment Objective:
- Growth Funds: Aim for capital appreciation.
- Income Funds: Focus on providing regular income.
- Tax-Saving Funds (ELSS): Offer tax benefits under Section 80C.
Equity Mutual Funds
Equity mutual funds invest more than 80% of its money in shares( stocks) of companies. These Equity Mutual funds are further divided into large cap, mid cap and small cap mutual funds, on the basis of market capitalisation of stock invested.
For instance, if a particular mutual fund scheme invests in large-cap companies’ stocks ( eg Reliance, Tata, Infosys – highest market capitalisation stocks), it is an equity mutual fund scheme. Another MF scheme invest in mid-cap stocks, is mid-cap MF.
Debt Mutual Funds
Debt mutual funds invests money in bonds, debentures and money market instruments.
There are different kind of debt funds based on duration, risk and type of investments.
How Do Mutual Funds Work?
When you invest in a mutual fund, you buy units of the fund. Each each representing a portion of the fund’s holdings.
The value of these units is determined by the Net Asset Value (NAV), which fluctuates based on the market value of the underlying assets.
- You invest money in a mutual fund scheme.
- Various other people also invest in the same MF investment.
- MF units are purchased at current NAV ( one unit purchase price)
- You become part owner of MF Scheme
- A professional fund manager manages money on your behalf
- Money is invested in stocks/Bonds/ mix of both ( depending on scheme objective
- The return generated is reflected as a NAV increment/decrease.
- Expenses are deducted before NAV change
- Return is distributed among investors proportionately
Ways to invest in Mutual Fund
There are two ways to invest in a mutual fund investment
- One Time/ Lump sum Investment
- SIP ( Systematic Investment Plan)
Benefits of investing in mutual funds
There are multiple good reasons why you should invest in mutual funds. Few are listed below:
- Low Initial investment –
You can start investing with as little as Rs 500 each month. The minimum investment ( lump-sum) is Rs .5000 ( some funds have a minimum investment of Rs 1K )
You can start investing with as little as or start a SIP.
- Professional management – An experienced qualified professional manages your money in mutual funds.
Therefore whether you invest Rs. 500 or 500000 your money is managed professionally.
- Convenience -You can invest your money, redeem your mutual fund units, stop your SIP investment or continue your SIP while redeeming the previously invested amount.
Thus mutual funds offer you great convenience of investing.
- Liquidity –
Mutual Funds are highly liquid in nature (except close ended funds-you can withdraw after a fixed duration). Liquidity here means that you can withdraw your money anytime from mutual fund investment.
Even partial withdrawal is also possible (redemption is subject to exit loads).
For an example: suppose you are running a SIP of Rs. 5000 and after 2 years you require 50000 from your investment.
You can withdraw your 50,000 amount and still continue with your SIP
Diversification– Mutual fund offers high diversification because even a single Mutual Fund invests across 60 -70 stocks or securities.
This approach reduces risk of your investment compared to investing in single or multiple stock.
Say if you had invested in a stock & the market crashes than you will possess higher risk as compared to mutual fund scheme.
- Tax benefit – You can invest in tax saving mutual fund (ELSS – Equity Linked Saving Scheme).
Taxation is also lower in mutual funds as compared to other investment options.
Mutual Fund taxation – How your gains are taxed?
SIP Taxation-How SIPs Are Taxed
- Regulation: Mutual Funds are well regulated investment option with high transparency.
SEBI (Security and Exchange Board of India) is the regulating body for mutual funds.
All mutual funds are required to follow the norms, as laid down by SEBI.
These norms are amended from time to time .Thus ensuring protection of investors’ interest.
Mutual fund works under strict regulations from Security Exchange Board of India and thus makes it further better for you.
How to Start Investing in Mutual Funds
- Define Your Financial Goals: Determine your investment objectives and risk tolerance.
- Complete KYC Process: Fulfill Know Your Customer requirements, including PAN and Aadhaar verification.
- Choose the Right Fund: Research and select a fund that aligns with your goals.
- Decide Investment Mode: Opt for a lump sum investment or a Systematic Investment Plan (SIP).
- Monitor and Review: Regularly assess your investment’s performance and make necessary adjustments.
Key Terms to Know
- NAV (Net Asset Value): The per-unit value of the fund’s assets.
- Expense Ratio: The annual fee charged by the fund for managing your investment.
- SIP (Systematic Investment Plan): Investing a fixed amount regularly.
- SWP (Systematic Withdrawal Plan): Withdrawing a fixed amount regularly
- STP (Systematic Transfer Plan): transferring a fixed amount regularly to target fund
Conclusion
Mutual funds offer a structured and regulated avenue for individuals to invest in a diversified portfolio managed by professionals. Whether you’re aiming for long-term growth, regular income, or tax savings, there’s a mutual fund to suit your needs.
Ready to start your investment journey? Explore various mutual fund options and take the first step towards achieving your financial goals.
I hope this detailed post about mutual fund will help you understand mutual funds. I would like to hear from you.
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