What Is a Mutual Fund?

what is mutual fund

A mutual fund is an investment scheme where funds collected from different investors are managed professionally. Companies managing mutual funds are called Asset Management Companies (AMC). AMC appoint one or more fund managers (also known as portfolio manager). This portfolio manager on behalf of the investors makes investments in bonds, stocks, short-term money market, and different commodities to grow money. The money they invest is put into different assets classes in congruence with the goal of the mutual fund.

The professional fund managers ensure that the funds are spread well so that any prospective losses are counterbalanced. Mutual funds are a great way to manage savings without having to pay excessively high fees. This type of investment is ideal for investors who lack appropriate knowledge about investments as the decision is taken by the investment portfolio manager, while they can sit back and enjoy the fruits of their investment.

Are you thinking to spend on mutual funds? First know the difference between mutual funds and stocks.

How Is a Mutual Fund Set Up?

what is mutual fund

A mutual fund is when a sponsor/sponsors, trustees, AMC and a custodian set up to form a trust. The sponsor/sponsors is the promoter of a company and the trustees hold the possessions of the mutual fund for the advantage of the unit holders. SEBI or Securities and Exchange Board of India regulates the fund through investments in different securities. The job of an AMC is to assist their investors in locating different options of investing funds without the need of minimum investment. They manage funds for their investors for a certain amount of commission.

One who has the securities of different schemes of the fund under his supervision and is registered with SEBI is referred to as a custodian. The trustees oversee the AMC and ensure that it complies by the regulations of SEBI.

Before launching any scheme every mutual fund should be registered with SEBI.  As per the regulations of SEBI, two-thirds of the directors associated with the trustee company should be independent which means they shouldn’t have any connections with the sponsors. Along with this, 50% of AMC, directors should also be independent. Here are some practical tips to invest in mutual funds.

Types of Mutual Funds

Equity Mutual Funds:

Equity fund is a type of investment fund which purchases ownership in business usually in the form of stocks which are traded publicly. Sometimes the proprietorship happens privately when the investment is made in private companies which are not traded in the stock market. It is referred to as private equity.

Whether private or public the main objective of equity funds is to look for good opportunities and invest in profitable businesses that are expected to grow.

There are three categories of equity mutual funds:

Large-cap Mutual Funds:

what is mutual fund large cap

These mutual funds invest primarily large companies. The size of these companies is determined by their market capitalization. The 100 largest companies by capitalization are all categorized as large-cap companies.

Since bigger companies are well-established and have more experience, they are considered to be a relatively safe investment. Returns from this type of funds are modest but they are less risky too.

ICICI Focused Bluechip Equity Fund is an example of a large-cap mutual fund.

Mid-cap Mutual Funds:

what is mutual fund mid cap

These mutual funds make investments in middle size companies. The companies that are between the 100th and 200th position by market capitalization are considered mid-cap.

Mid-cap companies are considered riskier than large-cap companies. Such companies, usually smaller and newer, are less stable. However, along with the risk of poor performance, mid-cap mutual funds also present investors with the opportunity to grow very fast. People who are willing to risk their funds can invest here.

L&T Midcap Fund is an example of a popular mid-cap mutual fund.

Small-cap Mutual Funds:

what is mutual fund small cap

These mutual funds invest in small companies. Companies that are not the top 200 largest by market capitalization are categorized as small-cap companies. These companies are riskier than mid-cap companies as they are likely to close down even before they can begin to earn profits.

However, there are times when new and innovative concepts work and these companies are successful. At such stages, these companies can expand at very high rates. Thus, they are extremely risky.

Franklin India Smaller Companies Fund is an example of a small-cap mutual fund.

Equity-oriented Hybrid Mutual Funds:

what is mutual fund equity hybrid

This type of fund is a combination of debt and at-least 65% of equity. Such schemes are less unstable compared to pure equity funds. The debt investments offer a stable return. These types of investments are best suited for new investors.

ICICI Prudential Balanced Fund is one of the highest rated Equity-oriented hybrid mutual fund on our website.

Equity Linked Savings Schemes (ELSS): 

what is mutual fund elss

This is also known as tax planning mutual fund and is best suited for people looking to save tax. Benefits of up to ₹ 1.5 lakhs under Section 80C. They have a mandatory lock-in period of 3 years.

Know all you need to know about ELSS mutual funds..

Sector Funds:

what is mutual fund sector

This fund is invested especially in just one specific sector as per the guidelines of the fund. The performance of such funds varies greatly and is dependent on the industry or sector. If the sector performs well, the returns could be very high.

At the same time, it could also perform very poorly if the sector in question is doing bad. It is advised that new investors stay away from sector funds. Only people with good knowledge of a given sector should explore a mutual fund in that sector.

UTI Pharma and Healthcare Fund is a mutual fund that invests in the pharmaceutical and healthcare industry.

 

Arbitrage Funds:

what is mutual fund arbitrage

In case of these mutual funds, the money is not invested in equity but this fund is considered as an equity fund for taxation work. These funds utilize the price difference between cash and offshoots markets to make a profit.

These are best meant for people who are in very high tax brackets and wish to stock their money for a short time.

HDFC Arbitrage Fund is a good example of this type of a mutual fund.

Diversified Fund:

what is mutual fund diversified

Here, the investments are dependent on the market view of the fund manager. Such funds invest in companies of different categories of market capitalization ranging from small all the way up to large-cap companies.

Since they are invested widely, they are less risky than mid-cap and small-cap funds.

Debt Mutual Funds:

what is mutual fund debt

Best ELSS Mutual Funds

A debt mutual fund is a pool of investment where the main investments are fixed investments. A debt fund could be both long and short terms bonds, floating rate debt or money market investments and securitized products. The commission charged on investment of debt funds are lower than the equity funds as the management costs on an average is less.

Debt funds offer less returns when compared to equity mutual funds but also offer a lower rate of return.

Debt mutual funds are an excellent alternative to investing in fixed deposits or recurring deposits. The rate offered by debt funds usually ranges from 7-10% and unlike FD or RD, there is no lock-in period.

Know more about debt mutual funds. 

Income Funds:

what is mutual fund income

In this the, the money is invested in government and corporate bonds or other money market instruments that mature over a long period of time. They are susceptible to variations in the rate of interests. It is best to invest in them when the there is a possibility of interest rate fall. They are meant for investors who are willing to take a high risk and keep their investment for a long period of time.

Liquid Funds:

what is mutual fund liquid

Here, the investments are made in securities whose maturities do not exceed 91 days. Such funds are invested in liquid money market instruments. If the duration of investing is very short, liquid funds are brilliant! They offer returns similar to fixed deposits but are extremely liquid in that the amount can be redeemed very quickly.

Indiabulls Liquid Fund is a highly rated liquid fund.

Fixed Maturity Plans:

what is mutual fund fixed

This is when the investments are made in debt instruments that have a maturity date. These are close-ended debt mutual funds which means, they have a lock-in period. The securities are cashed on maturity and the profits are paid to the investors. People who have a high tax bracket should go for this mutual fund.

Gilt Mutual Funds:

what is mutual fund gilt

These are investments done in government securities. They are issued by the government so they don’t have any default risk. Gilt funds are quite susceptible to economic factors of the country and variations in the interest rates. They are long term investments and carry a high-interest rate risk.

An example of a gilt mutual fund would be SBI Magnum Gilt Long Term Plan.

Dynamic Bond Mutual Funds:

what is mutual fund dynamic

Here the investment is spread through different classes of money and debt market instruments that have different maturity periods. They tend to switch quickly between debt and equity and are quite unprincipled. They act as shields against market losses and lose lesser money compared to the funds when the market is down.

IDFC Dynamic Bond Fund is a dynamic bond mutual fund.

Debt Oriented Hybrid Mutual Funds:

what is mutual fund debt oriented hybrid

This is a kind of mutual fund which invests in debt and equity partially. The part of the investment made in equity would get more returns however, they are a little risky. Those looking to invest in such funds should consider waiting for at-least three years for maturity.

HDFC Balanced Fund is a good example of a debt oriented hybrid mutual fund.

Short Term Mutual Funds:

what is mutual fund short

It matures anywhere between one to three years and is comprised of debt securities. If the short term interest rates are up, the returns are good.

Ultra Short Term Mutual Funds:

what is mutual fund ultra short

The fund, in this case, is invested in two parts usually – the bigger portion is invested in short term debt securities while a smaller part is put in the long term debt securities. The maturity time for such funds can be anywhere between some months to one year.

Indiabulls Ultra Short Term Fund is a good example of an ultra short fund.

Benefits of Investing in Mutual Funds

what is mutual fund benefits

Mutual funds are great for both new investors and those who are in their advanced stage. They are quite profitable and help in attaining other financial goals such as tax saving too. Here are some quick benefits of investing in mutual funds.

Diversification

One of the main benefits of investing in mutual funds is diversification. Mutual funds usually invest in many types of instruments. An equity mutual fund will invest in various types of companies. Same with other types of mutual funds too. This way, even if a few investments perform poorly, the bulk of the investment remains safe.

Easy

Mutual funds are easy to buy and sell. Unlike other investments like real estate and gold, buying and selling units of mutual funds is very easy. If you invest in mutual funds using groww.in, you can buy or sell mutual funds from anywhere at any time!

Time and effort

In case of stocks, investors need to plan and research very carefully before making an investment. Doing so requires great skills and knowledge. Mutual funds have large teams with people having specialized knowledge of various domain – something very hard for individual investors to do. The research, time and effort required to invest in mutual funds is much less. And once invested, the bulk of the work is done by the mutual funds. You as an investor are not required to keep track of the mutual funds investments very frequently.

Low minimum amount

Mutual funds don’t require a lot of money to invest. They are distributed in installments making it easy for an average man to invest in them. You can start investing with an amount as low as ₹500.

Low volatility 

Mutual funds are transacted just once at the end of the day making them safe and lesser volatile, unlike the stock exchange that trades at all times of the day.

Ways to Invest in Mutual Funds

what is mutual fund ways to invest

There are two ways in mutual funds:

1. Lump Sum:

Lump sum investment refers to a one-time investment of money. If you have a large sum of money and wish to use it to earn more money, you can invest it in one go in a mutual fund of your choice. By doing so, you ensure that the amount is immediately mobilized to grow and generate more money for you. This is ideal for when you do not need the said amount for some time.

2. Systematic Investment Plan (SIP)

SIP investment is investing a fixed amount of money every month in a mutual fund of your choice. This is ideally suited to people who save a fixed amount of money every month and want to invest as and when they earn instead of waiting for the money to accumulate. SIP also offers you the advantage of rupee cost averaging – which basically ensures your you do not pay a very high price to purchase units of mutual funds over a long period of time.

Based on your situation and needs, lump sum or SIP might be ideal for you. Understand which of these two will be right for you.

There may be some risk involved in mutual funds but overall they are a better option for investment compared to any other type of investment.

Start investing in mutual funds now!

Happy investing!