Mutual Fund

Mutual Fund is a trust that pools money from investors having similar financial goals, and invests the money as per guidelines, to attain the stipulated objective.

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What are Mutual Funds?

Mutual funds are among the most popular investment tools among investors. This is because they are easy to understand and easy to trade in. In fact, even if you have never invested in mutual funds before – you would learn everything about mutual funds investment by the time you finish reading this piece. For beginners, mutual funds are the best way to invest in market-based securities.

The accessibility and variety available within mutual funds make it an important investment tool for experienced investors as well. Mutual funds allow an investor to tailor their portfolios towards various investing and saving objectives. They are an ideal tool when building corpus for a large expense.

Benefits of Mutual Funds

What does mutual funds mean?

Let us look at the formal definition of a mutual fund. Securities and Exchange Board of India (SEBI) defines mutual funds as “a mechanism for pooling money by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document”.

The underlying securities that a mutual fund invests in can be stocks, bonds, money market instruments, other financial instruments or a combination thereof. The combination of the underlying securities invested in, called holdings, makes up the portfolio of a mutual fund. The risk and return on investment varies, based on which type of securities make up the portfolio. For example, mutual funds with investment in equity shares typically carry a higher risk than mutual funds that invest solely in debt instruments. Similarly, expected equity mutual fund returns are higher than debt mutual fund returns. More about various types of mutual funds is also discussed later.

It is important to remember that an investor does not own shares in any of the holdings; but owns a representation of those holdings – called units. For example, if one holds units of a mutual fund that has Reliance India Limited (RIL) in its portfolio – one still does not directly own any share of the underlying RIL stock.

Mutual funds investments are considered diversified, as a fund invests in securities across a wide variety of industries and sectors. This allows investors to enjoy the benefit of diversification without having to individually own multiple securities. Top mutual fund houses offer schemes that diversify both within a type of security and across different types of securities. Remember that your investment portfolio must be made up of different investment tools.

Mutual funds issue units to the investors according to the quantum of investment made. This ensures that profit or loss from the underlying securities is shared among the investors – also known as unitholders – in proportion to their individual investments.

A mutual fund is required to register with SEBI before they can offer units for sale to investors at large.
Before you learn to invest in mutual funds, let us find out how these work.

How mutual funds work?

Mutual funds in India are set up as trusts. These trusts have sponsor, trustee, Asset Management Company (AMC) and custodian. A sponsor (or sponsors) set up the trust and is equivalent to a promoter in a company. The trustees hold the mutual fund’s properties on behalf of the unitholders. AMC manages all the investments made by the fund. They choose the securities to invest in and the quantum of investment to be made. AMC must be approved by SEBI to manage a mutual fund. Custodians hold the securities that the mutual fund invests in. Custodians must register with SEBI before they can take custody of the underlying securities of a mutual fund scheme. The trustees are required to monitor the performance of mutual fund investments and ensure that the fund complies with all relevant SEBI regulations.

Further, SEBI mandates that at least two-thirds of the directors of trustee company or board of trustees are independent – i.e. have no relationship with the sponsors of the mutual fund. It also mandates that 50% of the directors of the AMC are independent.

Mutual funds pool money from the unitholders and buy other securities using this money. Therefore, the value of the mutual fund depends on how the underlying securities perform. When you buy a unit of a mutual fund, you are buying a part of this portfolio’s value. The best mutual funds ensure that their portfolio is well-diversified to lessen the impact of any market shocks.

Types of mutual funds

There are many different types of mutual funds to choose from and invest in, with each promising to give better returns than the other. And if you are confused about which investments to choose from, you are not alone. However, you can determine which fund will work for you depending on the risk appetite, the immediate or long-term needs, and the expected returns. Other factors like tax exemptions, cost, and flexibility also play a key role.

Depending on the investment avenue, the funds are divided into 4 different categories. These comprise Equity Funds, Debt Funds, Balanced/Hybrid Funds and Commodity Funds

(A) Equity Mutual funds

Equity mutual funds invest all of the pooled money in equity shares of companies. Here, all of the money gathered from the investors in invested in different shares. Depending on the price rise or fall, the returns are distributed proportionately among the people. Funds of this type are classified as high risk because of the volatility associated with the stock markets. The best time to invest in equity funds is when you have surplus cash and are looking for good returns over the long haul.
Equity funds are further classified into different types depending on the market capitalization of the company the fund is investing in.

What is market capitalization?

It is the market value of the company’s outstanding shares. Market capitalization is important because it helps ordinary investors understand the size of a company. Understanding size is important to determine risk associated with the company or the stability associated with it. Based on the market capitalization, there are different types of equity funds. They are large cap, mid cap, small cap, and multi cap equity funds.; they are large cap, mid cap, small cap, and multi cap equity funds.


(B) Debt funds

Debt funds take the investors’ money and invest in different debentures, government bonds, and other fixed income assets. These are considered safe instruments. Hence, if you are looking for safe avenues for parking your money which can provide regular income, debt mutual funds are a good idea.
The different types of debt funds are: Income Funds, Liquid Funds, Dynamic Funds, Gilt Funds and Fixed Maturity Plans.

(C) Hybrid funds

Hybrid mutual funds invest in both equities as well as debt instruments. This is done to achieve diversification and assured returns. A hybrid fund would work towards wealth appreciation over a longer term and earn income over the short run through a balanced portfolio. Depending on the investment objective of the hybrid fund, the fund manager may invest funds in suitable proportions across equity and debt. Hybrid funds are safer than pure equity funds and deliver better returns that debt funds. As it is a blend of equity and debt, the former enables an investor to create wealth when the markets are doing well and the latter offers stability during downturns.
According to their asset allocation, hybrid funds can be further categorised into the following: Equity Oriented Funds, Debt Oriented Funds, Arbitrage Funds.

(D) Commodity Funds

There are commodity funds – which are of the following types: Gold funds and Gold ETFs.
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Now that we have covered the classification of mutual funds according to categories, there are classifications based on structure as well. These classifications apply for high risk funds as well as low risk funds. Structural classifications are useful when determining the number of units that can be bought and sold, the periods and intervals for buying and selling, the flexibility associated with the fund, etc.

Advantages and Disadvantages of Mutual Funds

Advantages of MFs

There are numerous advantages of mutual funds. Mutual funds can best be described as coming of age investment methods. Mutual funds provide a whole lot of advantages. Some advantages are - simplicity, professional management, reduced cost and diversification. Let us take a look at some of the advantages:

Disadvantages of MFs

There are a few disadvantages of mutual funds despite the myriad benefits it offers.

How to invest in mutual funds

A prospective investor would have to consider various factors before planning to invest in a mutual fund online. Here are some of them:

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