Mutual funds is a term that all of us hear more and more often on televisions,newspapers and when we go to banks, in past few years mutual funds as an investment instrument for retail customers has really taken off , more and more people are aware of mutual funds and are keen to invest in mutual funds now, this has gradually happened over time due multiple reasons some of them are summarized below
- Better regulatory environment from SEBI resulting in higher confidence of investors in mutual fund schemes
- Increased public awareness efforts by AMC’s ( Asset Management Companies) which run mutual funds
- Improve in distribution of mutual funds both offline and online
This post will help you to know all you want to know about mutual funds .
What is a mutual fund
According to wikipedia ” Mutual fund is a professionally managed investme that pools money from many investors to purchase securities”. Let me try to explain it more in Indian context, Mutual funds legally are trusts which can solicit investments from retail and institutional investors, these investors become trustees in these funds , mutual funds in turn can invest this money in different securities, in general mutual funds have to tell you what kind of securities they are going to invest your money in and all of this is regulated by SEBI in India.
Role of Mutual Funds
Primary role of mutual funds is to assist individual investors in earning income or creating wealth, Mutual funds help harness large amounts of money from different investors and invest in securities of different kind, so in broader economic perspective mutual funds also help make money available to corporate or business houses which they invest in producing more goods and services, which ultimately runs the economic cycle ans provides growth to economy.
History of Mutual Funds in India
First mutual funds were introduced in India were in 1963 when Unit trust of India was establishes with the act of parliament, first scheme was launched by UTI in 1964 , things did not move too fast till early 1990s when liberalization era kicked in and banks and other financial entities were allowed to sell mutual funds starting with public sector banks and then post 1993 private sector banks have also been allowed to offer mutual funds and since than mutual fund industry has grown at a stupendous pace and now we have more than 1500 mutual fund schemes running in India have more than 12 lac crores of assets under management
Advantages of Mutual funds for Investors
Mutual funds have significant advantages for individual investors over any other modes of investment some of these are summarized below
Professional Management :
Mutual funds because they pool together lot of funds can afford hiring high quality professional managers to manage this money, so an individual investor also gets access to professional managers managing his money, doing best quality research and investing in right areas all of this would have not been possible other wise.
Diversified Portfolio at low investments
Mutual funds provide investors natural opportunities for small retail investors to diversify their portfolio. Mutual funds invest in range of securities so even if you invest a small amount of Rs 1000 you will be able to hold a diversified portfolio of assets.
Economies of Scale
As mutual funds have large pool of money to manage they can afford to hire best talent to manage the money conduct the best research as the cost of this will be spread over large amount of funds under management, this economies of scale get passed on to individual investors who could not have afforded all of this.
Mutual funds do not need to pay tax on incomes they earn so in theory investors can keep on growing their money and defer paying taxes on the same this allows your money to grow faster unlike in FDs where you have to pay the tax every year on the income earned
Mutual funds also provide avenues to investors to take out money at any time, this depends on structure of the mutual funds either mutual funds allow investors to exit at any time or at fixed time and for some schemes on closure of the scheme, this helps investors with liquidity and their money is not stuck up in a illiquid asset.
Mutual funds also provide systematic ways to invest so that you do not need to time the market and can systematically invest in funds, you can also systematically withdraw your money this brings in discipline as well as help you manage your investments better
Type of Mutual Funds
Based on investment objectives Mutual funds can be classified in following ways
1. Equity Funds
These funds have major investments in securities related to equity stocks and equity related instruments like convertible debentures , these funds have an objective to grow your wealth by investing in growth stocks some important types of equity funds are summarized below
a) Diversified Equity fund
These funds invest in a divers equity portfolio which cuts across sectors and companies the purpose is to reduce risk and at the same time also increase return
b) Sector Funds
These funds invest in specific sector equities for e.g a pharma sector fund will invest in stocks of companies which related to pharmaceutical industry, these kind of funds bring specialized investment practises and expertise in those sectors.
c) Large Cap Funds
These funds or schemes invest major part of their investments in big companies, with large capitalization on stock market, these are normally the blue chip companies ,these are relatively safe stocks
d) Mid cap/Small cap Funds
These funds invest in mid cap and small cap companies which by nature are volatile these funds carry high risk than large caps but also bring in higher returns
Thematic funds invest with a certain theme like say Infrastructure, these funds will then invest in all companies related to infrastructure sector.
f) Equity Linked saving schemes
These kind of funds provide tax deductions for the investors and they invest in equities, they have a lock in period of 3 years so you cannot withdraw money for 3 years from these funds
2. Debt Funds
These funds invest only debt securities these can be gilts or g-secs ( government securities) , commercial paper or corporate debt securities, these funds have an income objective and not a growth objective, following are the main types of debt mutual funds available
a) Gilt Funds
Gilt funds invest only in t-bills ( treasury bills) or g-secs ( government securities) these are the safest possible investments as they are backed by sovereign government guarantee
b) Diversified debt funds
Diversified debt funds invest in mix of government securities like t-bill,g-secs,commercial papers and corporate bonds they can be short tern debt funds or long term debt funds depending on maturity of underlying securities invested in
c) Junk bond funds
Junk bond funds are funds which invest in risky corporate bonds,which have poor credit quality.
d) Liquid funds
Hybrid funds invest both in a combination of debt and equity securities, some of them also invest in gold, they are primarily following type of funds
a) Monthly Income plan
They provide regular income to the investors and such have to invest in debt securities but they also invest small portion in equities which gives them flexibility of a slightly higher return
b) Capital protection funds
Thy are closed ended , which are structured to ensure that investors get their principal back, irrespective of what happens to the market. This is ideally done by investing in Zero Coupon Government Securities whose maturity is aligned to the scheme’s maturity.
How to invest in Mutual Funds
Mutual fund investments can be made offline through registered mutual fund agents and you would need to do fill up the application form provide some details , attach relevant documents and you should be ready to go, based on your choice of fund/scheme you will be allotted folio number, you can also invest online as lot of distributors provide this facility. you will have to provide certain documents for KYC and give mandate for ECS, you can start with a SIP or a Lumpsum investments
Frequently Asked questions about Mutual Funds
1. What is NAV?
NAV is sum total of market value of all shares, cash, bonds minus the liabilities divided by number of outstanding units for the fund.
2. What is SIP
SIP stands for Systematic Investment plan which is a systematic way to invest in mutual funds, SIP ensures you invest periodically in a specific mutual funds, the money is deducted from your bank account at a regular interval,SIP ensures discipline as well averages the cost of buying over a period of time
3. What is SWP
SWP stands for systematic withdrawal plan is a service provided by mutual funds to provide specific payouts to individuals at pre-defined time intervals, SWP helps people who are retiring to have a constant influx of income
4. Are mutual funds investments risky
All mutual fund investments who have any exposure to equities carry a market risk linked to underlying stocks also mutual funds which invest in debt funds carry an interest rate risk as risk rates changes your return can be impacted.
5. I have Rs 10,000 which mutual fund should in invest in
I answered a similar question here