What is Mutual Fund?
A mutual fund is an investment fund that is professionally managed. It pools money from many investors to purchase securities. There both i.e advantages and disadvantages are linked with Mutual funds compared to direct investing in individual securities.
A mutual fund exists in the form of a Trust having a sponsor. They are registered with government Authority SEBI (Securities Exchange Board of India) and SEBI approves the Asset Management Company (AMC) which manages the fund. The trustees are the persons who take care of the trust to ensure the compliance regulations relate to the fund.
Following are some of the terms which are related to mutual funds and investors should know about all these terms.
- Offer document - This is a formal document that describes about the features of the fund. It contains the fund’s objective and the asset classes in which the investment will be made by that fund. It also describes about the terms and conditions of the fund and other details like who will be fund manager,what are the risk factors and some other financial details . It is strictly advised to Investors that they should read the offer document and other related documents carefully before making investment in a fund.
- Assets Under Management (AUM) - AUM is total market value of funds being managed by a mutual fund company.
- Net Asset Value - This refers to the per unit price of the fund. This price keeps on changing on the basis of the performance of the fund.
- Fund Units the amount invested in mutual funds are segregated into small units and these units are known as fund units. Higher the investment amount, higher will be the number of units.
- Lock-in Period - there is lock in period in certain funds during which units cannot be sold i.e. investors cannot liquidate their investment units during this period. If the investor sells then there will be penalty or loss of benefits.
- New Fund Offer (NFO) - these are new funds/schemes launched by an AMC. Investors can make investment by buying units of the new funds at the offer price.
- Entry Load / Exit Load – when investor purchases/ sells the units, the AMC charges some amount to that investor on the investment/ selling amount and these charges are known as entry/ exit load.
- Expense Ratio - This ratio indicates the expenses incurred by the fund in relation to the total assets managed by that fund.
- Redemption - When the investor sells his/her units then it is known as redemption.
Advantages of investing in mutual funds
Mutual funds are very popular investment product in India and this market is becoming more popular as the new funds and schemes are getting entered in the market. There are some reasons why an investor should invest in mutual funds as outlined below:-
- Risk Diversification - As investment is made by fund in different securities which reduces the risk factor and hence risk diversification is achieved.
- Different funds to invest - There are different types of funds in which an investor can make investment like equity funds, debt funds, hybrid funds, fund of funds, money market funds, sector funds, regional funds, index funds etc.
- Professionally managed - Mutual funds are managed by fund managers, who are professionals of this field, of asset management companies. They use their expertise to minimise risks and maximise returns for investors. This professional experience becomes very essential as it is difficult for individuals to decide in which assets they should invest.
- More liquid investment - Except for the lock in period of attached funds, Investor can buy and sell units of fund at any point of time which makes this investment product more liquid investment.
- Regulated investments - SEBI (Securities Exchange Board of India) is regulatory authority which provides the regulation for the funds and ensures that all funds are dealings as per regulations. This makes these investments as regulated investments.
- Tax benefits - There are number of schemes which serve the purpose of tax benefits. It means if an investor invests in these funds and fulfills the conditions attached then he/she will be eligible to get deductions under income tax Act.
- SIP options – These are the investment options in which an investor invests small amounts on a regular basis to avail benefits of rupee cost averaging and if an investor cannot invest lump sum amount then he can choose these Schemes.
How to make investment in mutual funds
There are two ways to invest in mutual funds:-
- Direct scheme - As investment is made by fund in different securities which reduces the risk factor and hence risk diversification is achieved.
- Regular/Agents scheme - Under this scheme, the professionals assist the customers for all documentation and provide other professional advice as well. They help in application process and other related issues e.g. cancellation, redemption, transfer of units and other dealings with the company.
Who are eligible for investment in mutual funds in India?
There is wide range of Persons who can invest in mutual funds like Resident Individuals, NRIs, PIOs, Partnership Firms, HUFs, Trusts, Companies, Cooperative Societies, registered FIIs, QFIs, Banking and Non-Banking Financial Institutions, etc. This is an illustrative list of different types of investors of mutual funds in India.
Benefits of investment through online portals
As digitalization is going on in very fast manner, accordingly online transactions are becoming very popular for following reasons:-
- Easy comparison - there are number of online web portals for these financial services which provide the information of multiple schemes of different funds and it acts as single-point portals for viewing and comparing the schemes.
- Convenience - As every information is provided through online portal so one can apply for the Schemes from own office or home comfortably.
- Independence - All information like offer document, brochures and other material, are available online for easy perusal. This makes investors aware of any misleading information by agents and helps them in forming independent decisions.
Different Types of mutual funds in India
There are many different types of mutual funds categorized based on structure & asset class as below mentioned:
Based on asset class
- Equity Funds - The funds that invest in equity stocks/shares of companies are known as equity funds. These are also known as high-risk high return funds.
- Debt Funds - Those funds which invest in debt instruments like government bonds, company debentures, and other fixed income assets are known as debt funds. As these funds provide fixed returns, these are considered safe investments compared to equity funds.
- Money Market Funds - money market funds are funds that invest in liquid instruments e.g. T-Bills, CPs, and CDs etc. These funds are beneficial for those investors who want to invest for shorter period with good returns.
- Balanced or Hybrid Funds - When fund is invested in such a manner that some investment portion is invested in equity assets and some in debt assets then the fund is known as balanced or hybrid funds.
- Sector Funds - when fund is invested in particular sector of the market like Infrastructure sector then the funds are known as sector funds. Risks and Returns are linked to the performance of the sector which the fund has chosen.
- Tax-Saving Funds - These are funds that invest primarily in equity shares. Investments made in these funds qualify for deductions under the Income Tax Act. They are considered high on risk but also offer high returns if the fund performs well.
- Fund of funds - These are funds that do not invest in different asset classes but they invest in other mutual funds. Risk and returns depend on the performance of the target fund.
Based on structure
- Open-Ended Funds - Those funds in which buying and selling of units can be made at any time. As these funds provide more liquidity they are mostly preferred by the investors.
- Close-Ended Funds - Those funds in which units can be purchased only during the initial purchase offer period and can be redeemed at a defined maturity date.
Based on investment objective
- Income funds - when money is invested with the purpose of providing capital protection and regular income to investors then these income funds are preferred.
- Growth funds - Under these schemes, money is invested primarily in equity stocks with the purpose of providing capital appreciation. They are considered to be risky funds but are ideal for investors with a long-term investment timeline.
- Liquid funds - For liquidity purpose, money is invested in short-term or very short-term instruments like T-Bills, CPs, CDs etc. They are considered relevant for those investors who seek low risk with moderate returns.