What is Mutual Fund? Here’s Everything You Need to Know!

Hey Friends!

Are you a Beginner? Do you want to invest in mutual fund schemes?

If the answer is yes, then you are on a right track.

Most of us want to invest in mutual funds, but we often lack the proper knowledge and guidance to start investing. So, in this article, I have tried my best to provide all the insights that will give a kick-start in your first mutual fund investment.

What is Mutual Fund?

Mutual Fund is an investment vehicle that pools/collect money from several investors having common investment objective and then invest in securities like stocks, bonds, and money market instruments (short-term debts). In simple words, it means Collective Investment. This collected fund is known as the Asset Under Management (AUM).

If you want to invest your money in investment options like Real Estate, Stock Market etc, then you should have a deep understanding of the market as well as finance.

But that is not the case with mutual fund investments, as your money is professionally managed by fund managers.

Yes! You heard it right. These fund managers utilize their skills and experience to invest the collected funds (AUM) in such a way that it yields a huge profit.

In this way, we can also make money through mutual fund while we are sleeping. Isn’t that amazing? Moreover, it gives you an opportunity to become a shareholder of companies which you may not afford on an individual basis.

So stop worrying about the myths and take a wise decision by starting an investment in mutual fund today itself.

How Mutual Fund works?

Most nascent investors get confused about mutual fund being a company. Actually, Mutual Fund is not a company by itself. They are the products of an Asset Management Company (AMC).

An Asset Management Company (AMC) is SEBI (Securities and Exchange Board of India) authorized investment firm/company that pools money from the investors through mutual fund schemes and invests it according to the scheme chosen.

We know that when we invest our money in Stock Market, then we get shares of companies in return. There is nothing different here too. Let’s see how!

Mutual Fund Company (AMC) collects money from us and allots mutual fund units in return. The value or price of the single unit is known as the Net Asset Value (NAV). Our profit or loss is determined by the rise or fall of NAV in the market. Let’s understand it with the help of an example.

Suppose you buy 10 units of a mutual fund with a NAV of Rs 100. This implies that your total investment is Rs 1000 (10 units * Rs 100).

Now, let’s assume that after one year, the price of NAV increased by Rs 10. This means NAV is equal to Rs 110 after one year. So, your profit can be calculated as–

Profit = Rs {110*10–100*10} = Rs {1100–1000} = Rs 100

Hence, you made a profit of Rs 100 after one year.

Let us have a quick look at the types of mutual funds.

Major Types of Mutual Funds:

Mutual Funds can broadly be divided into two parts:

1. On the basis of Asset Class

2. On the basis of Structure

On the basis of Asset Class

1.Equity Mutual Funds:

These types of mutual fund invest in Stock Market. So, if you wish to become the shareholder of companies then this is for you.

Equity mutual funds are known to give higher returns. This is the bright side of the fund.

On the other hand, it demands high risk if you look into its darker side. As a smart investor, you need to be well-versed in both these aspects. Let’s conclude it out.

Equity mutual funds give you the option to earn higher returns, but at the same time demand high risk appetite on your part.

2. Debt Mutual Funds:

These types of mutual fund invest in fixed-income instruments like Governments and Corporate Bonds, T-bills, Commercial Papers(CP), Certificate of Deposits(CD) and other Money Market Instruments.

Debt funds are ideal for investors who are risk-averse and are looking for a fixed-income generating source.

3. Hybrid Mutual Funds:

These are also referred to as the Balanced Funds. Hybrid funds invest in both equity and debt instruments. This is the reason why it offers higher returns than debt funds and is also less-risky than equity funds.

Hybrid funds are ideal for investors who want to build a diversified portfolio of both stocks and bonds. 

On the basis of Structure

1. Open-Ended Mutual Funds:

Open-ended mutual fund is an investment scheme which gives us an opportunity to buy/sell mutual fund units at any point of time. Most of the mutual funds in India are open-ended. Unlike closed-ended funds, these funds are not listed on the stock-exchanges. They also do not have a set maturity period.

2. Closed-Ended Mutual Funds:

Closed-ended mutual funds allow us to invest in the very beginning. There is no option to redeem units till the maturity period is over. These are listed on the stock-exchanges and have a fixed maturity period.

3. Interval Funds:

Interval funds are special type of mutual funds in which we are allowed to buy/sell the units only during a specified period. These periods are usually decided by the fund house itself.

Who should invest in Mutual Funds?

Mutual funds are not limited to any particular type of individual or community. It is open for all those who wish to meet their financial goals and have a desired investment objective. The financial goals here can be Short-term, Mid-term or Long-term.

Let me share an important note.

                                    Investors should be well aware of their Risk Profile and Investment Horizon before investing.

Are you familiar with the words highlighted above?

Don’t worry! I’ll get your job done.

Risk Profile is the ability to take risk, whereas Investment Horizon (also known as the time horizon), means how long you wish to stay in a particular fund/plan.

These factors play an important role in defining your financial goals. It would not be incorrect to say that these factors are directly related to your goals and needs .

If your requirements fall into the long-term category, then both your risk-appetite and investment horizon should be comparatively high in order to meet the target. The same principle applies to short-term goals as well, where you go with low-risk appetite and shorter investment horizon to meet the goal.

Is there any Perfect Time for Mutual Fund Investment?

This is a common question among newbie. There is no such perfect time when it comes to mutual fund investment. This is the beauty of mutual fund that you can start investing whenever you wish. But remember one thing that a delayed investment can prove costly. It has been well-said by Sant Kabir  “ kal kare so aaj kar, aaj kare so ab ’’ which means better do it today rather let it pending on tomorrow. It’s the sign of a good investor to make investing a habit.

Let’s conclude it out with some key points:-

• Mutual fund gives us the opportunity to invest whenever we wish.
• Avoid delayed investments and try to start as early as you can.

Benefits of Mutual Fund

1. Professional Management

Mutual Funds are professionally-managed by the Fund Managers. This is like blessing for those investors who don’t have time or skill or both to invest in financial instruments.

2. Choice

Mutual Funds offers a wide range of choice to its investors. The only thing you need to do is Select and Invest. Let’s make it more clear. Select a suitable scheme by analysing the risk and reward as per your goal and then invest in it.

3. Liquidity

This is another benefit of mutual fund where investors can redeem their investments even when the fund has not matured. However, a small penalty is levied as Exit Load from the investors.

The liquidity of a fund becomes important in situations when we urgently need money, but at the same time, the maturity period is not over.

4. Well-Regulated

Mutual Funds in India are governed by the Securities and Exchange Board of India (SEBI). This means that all AMCs in the country have to follow certain rules and guidelines as laid down by SEBI.

The structure of the mutual funds and the regulations by SEBI has ensured that investors get transparency in their investments.

An investor becomes well-aware of his investment portfolio every month. The availability of such information prompts investors to make healthy investment decisions.

5. Low-cost

Mutual Funds are very cost-effective. They charge a nominal operating fee from its investors which generally ranges from 0.5% – 1.5%. This operating fee is known as the Expense Ratio. However, the expense ratio levied by the AMCs should not exceed 2.5% as per the SEBI norms.

6. Diversification

This is the biggest advantage of investing in mutual funds. Mutual Funds diversify our portfolio by investing in different asset classes like Equity, Debt, Gold, Real Estate etc. in order to reduce the overall risk related to investment. The World’s greatest investor once said –

                                                                                “Don’t put all your eggs in one basket”

– Warren Buffett

What does it mean? Let’s figure out!

The logic behind this is that investing in a single asset class (with no diversification) can sometimes spoil our whole investment due to financial crisis and poor performance in the market. Diversification helps you to overcome the risk associated with underperformance of any individual asset class.

7. Tax-saving Benefits

Most people consider mutual funds as an investment-option only. But very few of them know that apart from an investment-option, mutual fund can also be used to save tax. This tax-saving scheme is known as Equity Linked Saving Scheme (ELSS). Have you ever heard this before?

We know that Government of India levy tax on our yearly income if it is greater than ₹2.5 Lakh ( > ₹2.5 Lakh ). This also means that no tax is applicable up to a yearly income of ₹2.5 lakh. But by investing in ELSS Funds, we are eligible for an additional tax exemption up to ₹1.5 Lakh as per the Section 80C of the Income Tax Act. Thus, we get a total tax exemption of  ₹4 Lakh(₹2.5 Lakh + ₹1.5 Lakh).

This was all about the Basics of Mutual Fund.

Hope you enjoyed reading it.

Happy Investing😊