Definition: A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.
Description: As an investor, you can buy mutual fund 'units', which basically represent your share of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund's current net asset value (NAV). These NAVs keep fluctuating, according to the fund's holdings. So, each investor participates proportionally in the gain or loss of the fund.
All the mutual funds are registered with SEBI. They function within the provisions of strict regulation created to protect the interests of the investor.
The biggest advantage of investing through a mutual fund is that it gives small investors access to professionally-managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult to create with a small amount of capital.
These days between work, family, and friends, most of us do not have the time to make or monitor personal investment decisions on a regular basis. Mutual funds have qualified professionals who do all this for you. This is the reason why, the world over, they have become the most popular means of investing.
Mutual funds minimise risk by creating a diversified portfolio while providing the necessary liquidity. Additionally, you benefit from the convenience of not having to bother with too much paperwork or repeat transactions. It is our belief that investors differ in their investment needs based on their personal financial goals.
It is recommended that you should, at the very beginning, identify your own financial goals, be it planning for a comfortable retired life or children's education. After defining the financial goals, you need to plan for them in an organised manner and look at investments that help achieve these goals.
Mutual funds vary in their investment objectives, thus providing you with the flexibility to create an investment plan based on individual financial goals. Investment experts recommend growth investments such as equity funds and stocks as a good choice for funding needs that are five years or more away, income funds to meet medium-term needs and liquid funds for short-term requirements.
Investing in a mutual fund offers you a gamut of benefits
Some of them are as below:
Small investments: With mutual fund investments, your money can be spread in small bits across varied companies. This way you reap the benefits of a diversified portfolio with small investments.
Professionally managed: The pool of money collected by a mutual fund is managed by professionals who possess considerable expertise, resources and experience. Through analysis of markets and economy, they help pick favourable investment opportunities.
Spreading risk: A mutual fund usually spreads the money in companies across a wide spectrum of industries. This not only diversifies the risk, but also helps take advantage of the position it holds.
Transparency and interactivity: Mutual funds clearly present their investment strategy to their investors and regularly provide them with information on the value of their investments. Also, a complete portfolio disclosure of the investments made by various schemes along with the proportion invested in each asset type is provided.
Liquidity: Closed ended funds can be bought and sold at their market value as they have their units listed at the stock exchange. In addition to this, units can be directly redeemed to the mutual fund as and when they announce the repurchase.
Choice: A wide variety of schemes allow investors to pick up those which suit their risk / return profile.
Regulations: All the mutual funds are registered with SEBI. They function within the provisions of strict regulation created to protect the interests of the investor.
Every investor has a different investment objective. Some go for stability and opt for safer securities such as bonds or government securities. Those who have a higher risk appetite and yearn for higher returns may want to choose risk-bearing securities such as equities. Hence, mutual funds come with different schemes, each with a different investment objective.
There are hundreds of mutual fund schemes to choose from. Hence, they have been categorized as mentioned below.
By structure: Closed-Ended, Open-Ended Funds, Interval funds.
By nature: Equity, Debt, Balance or Hybrid.
By investment objective: Growth Schemes, Income Schemes, Balanced Schemes, Index Funds.
There are hundreds of mutual fund schemes to choose from. Hence, they have been categorized by structure, nature and investment objective.
Types of mutual funds by structure
Close ended fund/scheme: A close ended fund or scheme has a predetermined maturity period (eg. 5-7 years). The fund is open for subscription during the launch of the scheme for a specified period of time. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units on the stock exchanges where they are listed. In order to provide an exit route to the investors, some close ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices or they are listed in secondary market.
Open ended fund/scheme: The most common type of mutual fund available for investment is an open-ended mutual fund. Investors can choose to invest or transact in these schemes as per their convenience. In an open-ended mutual fund, there is no limit to the number of investors, shares, or overall size of the fund, unless the fund manager decides to close the fund to new investors in order to keep it manageable. The value or share price of an open-ended mutual fund is determined at the market close every day and is called the Net Asset Value (NAV).
Interval schemes: Interval schemes combine the features of open-ended and close-ended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices. FMPs or Fixed maturity plans are examples of these types of schemes.
Types of mutual funds by nature
Equity mutual funds: These funds invest maximum part of their corpus into equity holdings. The structure of the fund may vary for different schemes and the fund manager?s outlook on different stocks. The Equity funds are sub-classified depending upon their investment objective, as follows:
Diversified equity funds
Small cap funds
Sector specific funds
Tax savings funds (ELSS)
Equity investments rank high on the risk-return grid and hence, are ideal for a longer time frame. Debt mutual funds: These funds invest in debt instruments to ensure low risk and provide a stable income to the investors. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. Debt funds can be further classified as:
Short term plans
Balanced funds: They invest in both equities and fixed income securities which are in line with pre-defined investment objective of the scheme. The equity portion provides growth while debt provides stability in returns. This way, investors get to taste the best of both worlds.
Types of mutual funds by investment objective
Growth schemes : Also known as equity schemes, these schemes aim at providing capital appreciation over medium to long term. These schemes normally invest a major portion of their fund in equities and are willing to withstand short-term decline in value for possible future appreciation.
Income schemes : Also known as debt schemes, they generally invest in fixed income securities such as bonds and corporate debentures. These schemes aim at providing regular and steady income to investors. However, capital appreciation in such schemes may be limited. Index schemes : These schemes attempt to reproduce the performance of a particular index such as the BSE Sensex or the NSE 50. Their portfolios will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weight age. And hence, the returns from such schemes would be more or less equivalent to those of the Index.
If you have even as little as a few hundred rupees to spare, you can start your investment journey with mutual funds.
Depending on your investment objectives and future needs, you can choose to buy a particular number of units of a fund. A mutual fund invests the pool of money collected from the investors in a range of securities comprising equities, debts, money market instruments etc., with a nominal AMC fees. In proportion to the number of units you hold, the income earned and the capital appreciation realised by the scheme will be shared with you accordingly.
When you deposit money with the bank, the bank promises to pay you a certain rate of interest for the period you specify.
On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the fund manager invests your money as per the investment strategy specified for the scheme. The profit, if any, minus manager expense, is reflected in the NAV or distributed as income. Similarly, loss, if any, with the expenses, is to be borne by you.
Mutual Funds, besides equities, can also invest in debt instruments such as bonds, debentures, commercial paper and government securities. Every mutual fund scheme is governed by the investment objectives that specify the class of securities it can invest in.
Diversification ? Investors can spread out and minimize their risk up to a certain extent by purchasing units in a mutual fund instead of buying individual stocks or bonds. By investing in a large number of assets, the shortcomings of any particular investment are minimized by gains in others.
Economies of scale: Mutual funds buy and sell large amounts of securities at a time. This helps reduce transaction costs and bring down the average cost of the unit for investors.
Professional management: Mutual funds are managed by thorough professionals. Most investors either don?t have the time or the expertise to manage their own portfolio. Hence, mutual funds are a relatively less expensive way to make and monitor their investments.
Liquidity: Investors always have the choice to easily liquidate their holdings as and when they want.
Simplicity: Investing in a mutual fund is considered to be easier as compared to other available instruments in the market. The minimum investment is also extremely small, where an SIP can be initiated at just Rs.50 per month basis.
When it comes to mutual funds, putting all your eggs in a single basket is never a wise option. This is due to the market volatility and the risks that come with it.
But you can always minimise them by distributing your investments among various financial instruments, industries and other categories. Here the intent is to maximise returns by investing in different areas, where each would react differently to the same event. This not only buffers the impact of a market downturn, but also allows for more potential rewards by offering a broader exposure to various stocks and sectors.
Net Asset Value (NAV) is the actual value of one unit of a given scheme on any given business day. The NAV reflects the liquidation value of the fund's investments on that particular day after accounting for all expenses. It is calculated by deducting all liabilities (except unit capital) of the fund from the realisable value of all assets and dividing it by number of units outstanding.
Fund managers constantly monitor market and economic trends and analyse securities in order to make informed investment decisions. They play a vital role in implementing a consistent investment strategy that is in synergy with the goals and objectives of the fund.
These are funds that invest exclusively in stocks that fall into a certain sector of the economy. This scheme is perfect for investors who have decided to confine their risk and return to one particular sector. Thus, an Infrastructure Fund would invest in companies that manufacture and support companies which deal with construction, raw material production, etc.
Investors obtain capital appreciation on their investments under the Growth Plan. However, under the Dividend Reinvestment Plan, the dividends declared are reinvested automatically in the scheme.
SIP is a method of investing a fixed/regular sum every month or every quarter. With the growing everyday expenses, it becomes difficult to accumulate a considerable sum which can be invested at one go.
But with an SIP, you can start with a modest amount of Rs. 250 every month and this can be invested in any scheme of your choice as most mutual funds have this facility for their schemes.
The unit holder may set up a Systematic Withdrawal Plan on a monthly, quarterly or semi-annual or annual basis to redeem a fixed number of units. The systematic withdrawal plan, besides being popular among investors looking for consistent cash flows from their investments, is helpful for retirees to support their expenses.
The NAVs are published in financial newspapers and also available on the AMFI website on a daily basis.
Income, expenses, commitments, financial goals and many other factors vary from person to person.
So before investing your money in mutual funds, you need to analyse the following:
Investment objective: The first step should be to evaluate your financial needs. It can start by defining the investment objectives like regular income, buying a home, finance a wedding, educating your children, or a combination of all these needs. Also your risk appetite and cash flow requirements form an important part of the decision.
Choose the right Mutual Fund: Once the investment objective is clear, the next step would be choosing the right Mutual Fund scheme. Before choosing a mutual fund the following factors need to be considered:
NAV performance in the past track record of performance in terms of returns over the last few years in relation to appropriate yardsticks and other funds in the same category Risk in terms of unpredictability of returns Services offered by the mutual fund and how investor friendly it is Transparency indicated in the quality and frequency of its communications It is always advisable to diversify your money by investing it in different schemes. This not only cuts down on the risk, but also gives you a chance to benefit from multiple industries and sectors.