You may have to take a risk in mutual funds, but it is very less as compared to the stock market. Mutual fund specialists invest small amounts in individual stocks.
Nowadays everyone wants to invest in stock market. There are two ways to invest in the stock market. First the investor should open a demat account and invest in the market through it. Alternatively, you can get huge returns over a long period of time with the help of SIPs in mutual funds.
Either way your money is exposed to market risk, so deciding what to invest in depends on how well you understand the market. If you do not invest money with proper knowledge and understanding, your money will sink.
What is Mutual Funds
Mutual fund in Hindi means mutual fund. In a little simpler language, an amount shared by many people can be called a mutual fund. Actually, in mutual fund, money of many people is pooled together in stock market or investment schemes. This way your shared money is collectively invested in a mutual fund. Whatever profit he earns is shared according to everyone’s share of the investment.
Where and how to invest people’s money is done by a team of experts (financial experts). This team works under the Fund Manager. Professionals who understand the market and share market are kept in that team. Considering the past record and future prospects of the companies and their shares, the team invests people’s money in such a way that it can give good returns with minimal losses.
An example of investing in mutual funds
Suppose there is a packet of 20 chocolates whose total cost is Rs.1000. One condition of this packet is that it can only take the entire box. Now let us assume that a person is not in a position to buy it completely, or is not ready to buy the whole packet at once. In such a situation 5 people are thinking to buy it together and are buying by depositing 200 rupees.
Here we see that each friend gets four chocolates. Think of a mutual fund as a whole packet of chocolates and consider each chocolate as a unit. So in this way each friend gets 4 units of mutual fund. His money is invested in those 4 units and he will get returns only from those 4 units.
Mutual Fund Unit
Mutual funds have various investment instruments. It can also have many types of shares and it can also have many types of bonds. Similarly derivatives and treasury bills can also be included. This whole porridge of investment is divided into few numbers. 1 part of it is called a unit or a unit of that mutual fund.
For example, mutual fund ABC, in which 20% is invested in stock A, 10% in stock B. 20% is invested in stock C and 5% in stock D. 30% is invested in government bonds. 10% is invested in cash derivatives and 5% in treasury bills.
When a person acquires a unit of this mutual fund, he is entitled to own all these types of investments as per his investment ratio. Returns based on the combined performance of all investments also qualify.
Now let us assume that the price of one such mutual fund unit is Rs. 50 and you have invested a total of Rs.1000. So you will have 20 units of that mutual fund.
Definition of Mutual Fund
A mutual fund is like a trust, which pools money from different investors who share a mutual investment objective. This trust is managed by a professional fund manager. The manager uses these funds to invest in equities, stocks and various money market instruments, which help in wealth growth. The income of this collective investment is distributed proportionately among all the investors after deducting some expenses.
An example of a mutual fund
Imagine there is a box of 12 oranges, which cost 40 rupees. There are 4 friends who want to buy this box, but each has only 10 rupees. They decide to pool their money and buy the box. He is entitled to 3 oranges for each of his contributions. Now try to compare this example with a mutual fund, the cost per unit is calculated by dividing the amount invested by the total number of shares/equities. Each investor is a part owner of the fund and collectively owns the entire pool of the fund
What is the NAV of a mutual fund?
Net asset value (NAV) is the value of a mutual fund, which is essentially the combined market value of the securities, stocks and bonds held by the fund after deducting all expenses and charges. If you add the market value of all the shares and securities in the fund and divide it by the total number of units in the fund, you arrive at the NAV per unit.
Who should invest in mutual funds?
Primarily one can invest in mutual funds as the required investment amount per month is Rs. 500 start. For someone who is not risk averse (i.e. risk tolerant) and wants to grow their wealth with a small investment on a monthly basis, this can prove to be a good option. Additionally, there are multiple product options under mutual funds, which cater to different saving objectives like education, marriage, retirement etc. People have countless options and plans to pick and choose from.
Types of Mutual Funds
Mainly mutual funds can be classified as open ended and close ended funds. As the name suggests, open-ended mutual funds have no limits or restrictions. An investor can choose to enter or exit the fund at any time. It is perpetual in nature and available for subscription throughout the year, whereas closed-ended mutual funds come with a fixed maturity date, and are open for subscription only during the initial offer period. An investor can redeem his investment on the maturity date. SEBI (Securities Exchange Board of India) has classified mutual funds into these four categories, which are as follows –
Equity Mutual Fund
An equity fund is a type of mutual fund where at least 65% of the fund is devoted to equity and equity-oriented investments. Equity mutual funds are known for their high return potential. However, there are different types of equity funds based on their characteristics and risk-reward potential.
- Small-Cap Funds – Small-cap funds are equity funds that invest your money with a market capitalization of Rs. Investment in stocks of 500 crore companies is low. Small-cap companies generally rank below 250 on stock indices like the Sensex.
- Mid-cap funds – Mid-cap funds are equity funds that invest your money with a market capitalization of Rs. 10,000 crore invests 500 crore in shares of companies. The stock index ranks mid-cap companies from 101 to 250.
- Large-Cap Funds – Large-cap funds are equity funds that invest your money in shares of companies with large market capitalizations. Large-cap companies are ranked from 1 to 100 on the stock index.
- Multi-Cap Fund – A multi-cap fund is a type of equity fund that invests in shares of companies in market capitalization. The asset allocation is changed by the fund manager keeping in view the market to get better returns.
- Equity Linked Savings Scheme (ELSS) – ELSS is a type of mutual fund that comes under Section 80C of the Income Tax Act, 1961. An investor in ELSS fund Rs. 1,50,000 can claim tax deduction.
- Index Funds- An index fund is a type of fund that invests in indices (Nifty 50, Sensex, Sectoral Indices etc.). Its display shows the index it is copying from.
- Sector Fund – A sector fund or thematic fund is a type of fund that invests in stocks of a specific sector or industry like Pharma and FMCG.
Debt Mutual Fund
A debt fund is a mutual fund that provides returns to its investors by investing in various types of fixed income bonds and corporate bonds, treasury bills, government securities, etc. Types of Debt Fund –
- Income Funds – Income debt funds invest in debt securities of various maturities but are mostly long-term investments. Its average maturity is around 5-6 years.
- Dynamic Bond Fund – Dynamic bond funds move dynamically between long-term and short-term funds with different maturity profiles. Dynamic bond funds move across various debt and money market instruments based on interest rate volatility.
- Short Term Funds – Short term debt funds have a maturity of less than 1 year to 3 years. It invests mostly in government securities, debt and money market instruments.
- Ultra Short Term Funds – Ultra-short term funds are debt funds with short maturity periods, but usually less than one year.
- Liquid Funds – Liquid debt funds are easily converted into cash and have a maturity of 91 days. Investments under liquid funds are made in treasury bills or certificates of deposit etc.
- Fixed Maturity Plan – A fixed maturity plan or FMP has a fixed lock-in period. This can range from months to several years. Due to the lock-in period, FMPs are not affected by changes in interest rates.
- Gilt Funds – Gilt debt funds invest only in securities issued by central and state governments and have long maturities.
- Credit Opportunities Fund – Investments are made in various types of instruments under Credit Opportunities Fund. Short term to long term investments are made with the objective of earning maximum interest.