A mutual fund is a versatile investment option that has the potential to generate a huge corpus of wealth over a period of time. There are several mutual funds in the market for all types of risk profiles to achieve the defined financial goals.
Fundamentally, mutual funds are collectively pooled investments from various investors. Let us understand mutual funds through an example.
Ravi, a salaried young investor, is willing to invest Rs 10,000 every month. He wants to invest in the stock market but finds it difficult to devote the time required for stock analysis. Being young, he acknowledges his lack of knowledge and experience.
Ravi has five other friends who are also in a similar situation. Here, Ravi along with his friends (six of them) are the investors.
They meet a financial expert who agrees to help them with their stock market investments. Each of the six friends decides to pool in Rs 10,000 to create a pool of funds.
Here, the pooled fund of Rs. 60,000 (i.e. Rs. 10,000 x 6) is the AUM of the mutual fund. AUM is ‘assets under management’. The financial expert is like the fund manager of the mutual fund.
The financial expert charges an annual fee of Rs. 2000 for the job. Here, the charges are like the management fees that mutual funds collect.
The financial expert does market research and creates a portfolio by investing in different stocks. He keeps a watch on the market movements and times the purchase and sale of shares accordingly. This is similar to the activities of the mutual fund manager.
Mutual fund schemes are available for fulfilling various investment objectives. You have funds for tax saving, retirement planning, and wealth creation to meet a wedding, foreign vacation, and other expenses like buying a dream car.
Based on the investment objective, the pooled money is invested in different assets to generate returns. The most used assets for investment are equity, debt, corporate bonds, and money market instruments.
The returns are reinvested for growing wealth or are distributed as dividends. Let us understand the working of mutual fund investment through an example.
Let us assume that a particular mutual fund gets a pooled fund of Rs. 1 Crore from 1000 investors. Each of them invested Rs 10,000.
Now, suppose that the fund house issues the mutual fund units at a net asset value (NAV) of Rs 10. Then the total number of units will be (Pooled fund / NAV) = 10 Lakh units. Each of the investors will get 1000 units.
The pooled fund of Rs.1 Crore is being invested in stocks, debt, and other instruments as per the investment objective.
Assuming that there is no change in the number of investors or portfolio holding. The price of stocks moves up and the value of the portfolio grows to Rs. 1.25 Crore. Now the NAV will be Rs. 1.25 Crore / 10 Lakh units = Rs. 12.5.
Holdings of the individual investors will be 1000 units x present NAV of Rs. 12.5 = Rs. 12,500. An increase from Rs. 10,000 to Rs. 12,500.
A few of the investors think of redeeming their mutual fund investment. Suppose, 50,000 units of mutual funds were redeemed which resulted in an outflow of Rs. 12.5 x 50,000 = Rs. 6.25 Lakhs.
Hence the AUM of the funds falls from Rs. 1.25 Crores – 0.0625 Crore = Rs. 1.1875 Crores. The remaining number of units is 10 lakhs – 50,000 = 9.5 Lakh units.
NAV after redemption is Rs. 1.1875 Crore / 9.5 lakh units = Rs. 12.5. You can see that the NAV remains at Rs 12.5 per unit.
Now let us assume that the price of the stocks in the portfolio fluctuates and falls, such that the portfolio value decreases form Rs. 1.1875 to Rs. 1.15 Crore. The NAV in such a scenario will be Rs. 1.15 crore / 9.5 Lakh units = Rs. 12.1052 per unit.
Suppose a person finds the situation suitable for investment. He invests Rs. 1 lakh in the scheme. He will get Rs. 1 Lakh / 12.1052 = 8260.912 units.
The portfolio value will rise from Rs. 1.15 Crore to Rs. 1.16 Crore and the scheme will have an additional 8260.912 units.
The above process continues and the NAV keeps on changing. NAV is calculated at the end of the day considering all the changes. In simple terms, this is how mutual funds work.
There are 8000+ mutual fund schemes available in the market. These schemes have the potential to fulfill all kinds of financial goals for various risk profiles.
These schemes are designed to match financial goals for all life events. For example, marriage, retirement, children’s education, asset (car, bike) purchase, and even for a foreign vacation can be managed through mutual fund investments.
The pooled fund amount is invested across various asset classes to avoid risk arising from a single asset. The performance is not dependent on a single asset class. Thus, investors get a chance to invest in a diversified portfolio through mutual funds.
Mutual funds invest in equity, corporate bonds, debt, debentures, and money market instruments like T-Bills, Government securities, Commercial Papers, Certificate of deposits.
Mutual fund house appoints an expert fund manager with years of experience in managing funds. The fund manager allocates, invests, tracks, and manages the pooled money.
He is responsible for the performance of the particular mutual fund scheme. The fund manager is supported by a research analyst and a team of professionals.
Thus, investment in mutual funds saves you from the pain of market research and timing. The expert management saves you time and effort.
For all the fund management and expenses, AMC charges fees, called the expense ratio. The expense ratio of most of the mutual fund houses are in the range of 0.5% to 2%. According to SEBI guidelines, the expense ratio cannot exceed 2.5%.
Even after the expense ratio, the mutual fund is a low-cost investment suitable for everyone. If you count the cost of time, effort, and energy that would go in making investments in various asset classes then it is definitely a smart and cost-effective way to invest.
Close-ended mutual funds have a lock-in period. This is a period in which investors cannot withdraw or redeem their mutual fund investment.
The lock-in period varies across mutual fund schemes. For example, the tax-saving funds (ELSS) have a lock-in period of 3 years.
The lock-in period restricts the tendency to withdraw on each NAV rise and helps in growing the money over a period of time, for a specific purpose.
On the other hand, open-ended mutual funds do not have a lock-in period. Investors can buy and sell units whenever they want.
The mutual fund gives you the flexibility to invest through a systematic investment plan (SIP). You can choose the investment amount and the frequency. The SIP can be as small as Rs. 500 per month and the frequency can be weekly, monthly or quarterly.
You can also invest in mutual funds through a single, one-time lump-sum payment.
Various mutual fund schemes allow you to switch funds. The switching facility is helpful as you get the chance to reallocate the fund to better performing scheme.
Mutual Funds offer a high amount of liquidity as compared to other investment options like FDs and PPF.
You can buy and redeem the mutual fund units at any time. Just place the redemption request and your redemption proceeds will be automatically credited into your specified bank account within 3 – 7 working days.
Equity mutual fund scheme invests a major portion of the pooled corpus in equity and equity-related securities like preference shares.
Equity investments are subject to market fluctuations and these are a high-risk high-return investment. Hence, equity mutual funds are better suited for aggressive investors who have a higher risk-taking capacity.
Equity mutual funds have the potential to generate a large wealth corpus over a period of time and therefore used for long-term investment goals. The life goals for which you can choose equity mutual funds are retirement planning, children’s education and creating multi-purpose wealth corpus.
Debt mutual fund schemes invest the fund corpus in different debt securities like corporate bonds, debentures, and money market instruments like T-Bills, certificate of deposits (CDs), and commercial papers (CPs).
Debt mutual funds are best for conservative or risk-averse investors who want to grow their money by taking a minimal amount of risk possible. The underlying securities are of high quality and fluctuate less than the equity.
Debt mutual fund scheme is ideal for short-term to medium-term financial goals like creating a fund for a wedding, buying a car or a dream bike, and foreign vacation. You can use the debt mutual fund to retire an outstanding loan.
Liquid mutual funds are useful for building an emergency corpus of funds. The liquid fund invests in short term debt and money market instruments having a maturity of up to 91 days.
Liquid mutual funds are highly liquid, safe, and have the highest credit quality underlying instruments. Hence, they are suitable for parking surplus investments.
You can use liquid funds for meeting emergency expenses arising from medical exigencies or temporary income/job loss.
ELSS is a specific mutual fund type used for tax savings and planning. Tax saving mutual fund is such that the investment up to Rs. 1.5 Lakh qualifies for a tax deduction under section 80C of the Income Tax Act, 1961.
ELSS invests a major portion of the corpus in equity and equity-related securities. Hence, they are better suited for an aggressive investor. Thus, ELSS serves the dual-purpose of tax saving and generating high returns.
ELSS has a lock-in period of three years post which the fund behaves like an open-ended scheme.
Hybrid mutual fund schemes invest the pooled funds in both equity and debt securities in a certain proportion. A hybrid mutual fund seeks capital protection and exposes only a certain portion to risk for additional returns.
Mutual fund schemes are suitable for all types of financial goals. You can choose a scheme that matches your risk appetite and financial goals.
Mutual fund investment is perfect even if you don’t have the expertise of financial markets. Investing in mutual funds is beneficial for an individual who does not have the time to monitor the markets and track his investments.
If you compare it with direct investment, investing via mutual funds brings in diversification benefits and cost reduction. Mutual funds help you invest in assets that may not be individually possible like Government securities (G-Secs).
Imagine the cost you would incur to diversify across assets. Additionally, due to economies of scale, mutual funds have the capacity to bargain lower brokerages with brokers, which reduces the brokerage costs.
Investment in mutual funds gives you the flexibility of SIP and Lump-sum, liquidity, and allows you to switch funds.
1. Systematic Investment Plan (SIP)
SIP is the preferred mutual fund investment method because of the flexibility it offers. First, SIP is affordable, you can start a SIP with an amount as small as Rs. 500 per month. Second, you have the option to choose the SIP frequency from weekly, monthly or quarterly payments.
Next, SIP gives the flexibility to pick a fixed amount depending on your cash flows. Which can be as low as Rs. 500 to any amount. Yes, one can invest any sum of money in mutual funds using SIP. There is no higher limit.
Additionally, using SIP you purchase mutual fund units in a phased manner that help you average purchase costs. The same SIP amount buys lower units in the high market and higher units in a down market.
The fixed regular SIP contribution builds a habit of saving and investing. Hence, SIP is better for salaried people. Business persons, with a better cash flow position, can also invest through SIP of higher value.
The other method of mutual fund investment is through a single, one-time lump-sum payment.
However, you do not have the benefit of cost averaging because you invest at a particular time, which could be favorable or adverse for investment.
The online mutual fund investment platform is a single account, hassle-free, and a quick way to invest in mutual funds.
Scripbox is a good example of an online mutual fund investment platform. These platforms help investors using the algorithmically selected suitable mutual fund schemes. You can track, manage, and redeem investments using a single platform.
The steps required to invest using an online investment platform are;
Mutual funds investment can be done directly online through the AMC website. You can visit the mutual fund house website and follow the below process;
Your existing Demat account can be used for investing and transacting in the mutual fund. But, you need to check with your stockbroker whether the stockbroker is registered as mutual fund distributors or not.
For investing, log-in to your Demat account and look for the option to invest in the mutual fund. In the next step, you need to choose the particular mutual fund scheme in which you want to invest.
Complete the investment by transferring the amount online.
You can invest in mutual funds through mutual fund registrars like Karvy and CAMS. Both the registrars offer online as well as offline investment options.
For investing online;
Mutual fund investments option offer several benefits and flexibility in terms of diversification, expert management, switching funds, investment, and redemption.
Mutual fund investment is for all types of investors. Whether you are single or married, rich or common, salaried or from business, there are mutual fund schemes to meet your investment purpose. Even corporates and financial institutions invest in mutual funds.
The mutual fund investing is pretty easy, as you just need to open the website of an online investment platform and follow a few steps. That’s all to start the journey.
Taxation on mutual funds is a complex topic. Taxes paid on your mutual fund investments vastly depend on factors such as what kind of funds you have invested in, the duration of your investment, which income tax slab you belong to and so on.