What is a Mutual Fund?
Mutual fund is a financial instrument that pools money from different investors. The pooled money is then invested in securities like stocks of listed companies, government bonds, corporate bonds, and money market instruments.
As an investor, you don’t directly own the company’s stocks that mutual funds purchases. However, you share the profit or loss equally with the other investors of the pool. This is how the word “mutual” is associated with a mutual fund.
You get the advantage of the expertise of the fund manager and regulatory safety of the Securities Exchange and Board of India (SEBI). The professional fund manager ensures a maximum return to investors.
What are Mutual Fund Units?
A mutual fund invests across a diverse range of securities. It builds the corpus by investing investors’ capital across all these securities. When an investor decides to invest in a mutual fund, they will ideally buy a part of the mutual fund. Like company shares, mutual funds are divided into fund units. Thus, to invest in a mutual fund, you should buy the fund units. Each unit will give you exposure to all the assets held by the fund. For example, if Fund X invests in Company A (20%), Company B (15%), Company C (10%), Company D (25%), and 30% in debt instruments. Thus, buying one fund unit will give you exposure to all the securities in the same ratio.
Each unit is bought and sold at the prevailing Net Asset Value (NAV). When purchasing a share, investors get ownership of the company. However, in mutual funds, purchasing units will not give ownership of any stock or bond. Thus, to invest in mutual funds, you must purchase the fund units at the NAV and similarly sell the units to realise gains.
Mutual fund investment is simple. You invest in a fund consisting of several assets. Thus, you need not risk putting all eggs in one basket.
Additionally, the headache of tracking market movements is not there. The mutual fund house takes care of the research, fund management, and market tracking. This makes the mutual fund a highly popular investment option for all types of investors.
An Asset Management Company (AMC) manages the mutual fund. Mutual fund investment starts with the pooling of money from several investors.
The pooled money is invested in a meticulously built portfolio of different asset classes like equity, debt, money market instruments, and other funds. Hence, you have the advantage of diversification, the time tested market mantra.
Additionally, your money is invested in instruments like Government bonds, that you wouldn’t be able to afford individually.
Also, the best part about mutual funds is that a team of experts along with the fund manager picks all the investments to build a portfolio. The investments are made according to the defined objective of the mutual fund.
Expert and professional fund management help you outperform the returns of traditional investment vehicles like a bank savings account and fixed deposits.
Also, as an investor, you are allotted units for your contribution to the pooled fund.
The portfolio value depends on the price movements of the underlying assets. The portfolio value is net assets divided by the number of outstanding units which is called the Net Asset Value (NAV)
Furthermore, the gains are reflected in higher NAV and lower NAV indicates a loss in portfolio value.
Types of Mutual Funds Based on Asset Class
Investors should pick mutual funds based on their financial objectives and risk appetite. Proper mutual fund selection helps you meet your life goals in the defined time period.
Mutual fund type depends on the defined objective and the underlying asset. Following are the categories of mutual funds:
1. Equity Mutual Funds
Equity mutual funds invest the pooled money majorly in stocks of different companies. Hence, equity mutual funds have an inherent higher market risk. Factors like earnings, revenue forecasts, management changes, and company & economic policy impact price movements and the returns. Returns from equity funds have high fluctuations. Hence, you should invest, if you have a fair understanding of the asset class risks associated with equity.
Types of Equity Funds
Equity fund can be further categorised depending on market capitalisation and sectors.
- Based on Market Capitalisation
- Large-cap Equity Funds – Invest in shares of large-cap companies that are well-established with a track record of performing consistently over a longer time period. These companies have sound fundamentals and are least affected by business cycles.
- Mid-cap Equity funds – Invest in shares of mid-cap companies. Mid-sized companies have relatively lower stability in terms of performance. But have the potential to grow more than the large-cap companies.
- Small-cap Funds – Invest in shares of small-cap companies. Small-cap companies have the highest potential to grow or fail. Thus, small-cap funds have a high-risk exposure but also offer an opportunity to generate the highest returns.
- Multi-cap funds – Invest in a defined proportion across all market caps. Based on cues and trend analysis, the fund manager allocates aggressively to capitalize on the volatility.
- Sector Based Equity Funds: Sector-based equity funds invest in stocks of a specific sector. For example, sectors like FMCG, technology, and pharma. Sector funds are prone to business cycle risk and sector getting out of focus.
2. Debt Mutual Funds
A debt mutual fund invests a major portion of the pooled corpus in debt instruments like government securities, corporate bonds, debentures, and money-market instruments. The bond issuers “borrow” from investors by giving an assurance of steady and regular interest income. Thus, debt funds are less risky in comparison to equity funds. The debt fund manager ensures that the fund is invests in the highest-rated securities. The best credit rating signifies the creditworthiness of the issuer in terms of regular interest payments and principal repayment.
Who Should Invest in Debt Funds?
Debt funds have less volatility and range bound returns as compared to equity funds. Thus, debt funds are safer for conservative investors who are looking to grow wealth with minimal risk.
In fact, the interest income and maturity amount are known beforehand. Thus, debt funds are best for short-term (3 to 12 months) and medium-term (3 to 5 years) investment horizon.
Type of Debt Funds
Following are the debt funds available in India:
- Dynamic Bond Funds: Dynamic bond fund investment basket comprises of both shorter and longer maturities. The debt fund manager aggressively tweaks the portfolio composition based on changing interest rate regime. This aggressiveness makes the debt fund dynamic, hence the name.
- Liquid Funds: The short maturity of the underlying securities (not more than 91 days) makes the liquid funds almost risk-free. It is better than parking funds in saving bank accounts as it gives better returns with much-needed liquidity. You can redeem liquid funds almost instantly. If you are short-term investors then debt funds like liquid funds could be better as you get returns in the range of 6.5 to 8%. Liquid funds are an effective tool to meet emergency fund needs.
- Income Funds: Fund managers invest majorly in securities with longer maturities to have more stability and regular interest income flow. Most of the income funds have an average maturity of 5 to 6 years.
- Short-Term and Ultra Short-Term Debt Funds: There is another category in the maturity range of 1 to 3 years. The fund manager takes a call on interest rate regime and invests in securities with maturity of the said range. This is suitable for those investors who are risk-averse and looking for interest rate movement safety.
- Gilt Funds: Gilt funds invest only in high-rated government securities. Since the government rarely defaults, it has zero risks. You can park your money in this instrument to have assured returns in longer maturity range.
- Credit Opportunities Funds: Credit Opportunities Funds are a relatively riskier instrument that focuses more on higher returns by holding low-rated bonds or taking a call on credit risks. The fund manager of credit opportunity funds relies more on interest rate volatility to earn higher returns.
- Fixed Maturity Plans: These closed-ended debt funds invest in fixed income securities like government bonds and corporate bonds. You invest only during the initial offer period and your money remains locked-in for a fixed tenure, which could be months or years.
Types of Mutual Funds based on Investment Objectives
Since mutual funds are all about the mutuality of common goals, mutual fund schemes are also categorized on the basis of the objectives of investors.
Following are some popular types of mutual funds based on investor objectives:
1. Growth Oriented Scheme
As the name suggests the primary goal of this type of mutual fund is to ensure wealth creation in the medium and long-term.
Aligned with the objective, the fund manager allocates the corpus predominantly (over 65%) in equities. With a focus on higher returns, the manager aggressively shuffles the portfolio to reap the benefits of market movements.
2. Income Oriented Scheme
The objective of the regular income could be achieved only when the underlying assets assure a steady return.
To meet the objective, fund manager of income funds allocate a major portion of the corpus in fixed income securities such as government securities, bonds, corporate debentures, and money market instruments.
Lesser risks and assured return makes it safe for regular income as dividends. However, these products have very limited potential for wealth creation in the defined period.
3. Balanced Fund
The name comes from the asset allocation as the fund is allocated in both equities and debt instruments in defined proportions. The objective of the balanced fund is to have reasonable growth and regular income with the lowest possible risk.
Fund managers of these funds normally allocated approx 60% in equities and rest on debt instruments. NAV of balanced funds is less volatile as compared to equity funds.
The balanced objective is suitable for those who want to have advantages of market movements and the safety of the debt market.
4. Liquid Fund
The objective of these schemes is to ensure liquidity, capital protection, and reasonable income in the short-term.
Most of the pooled fund is invested in short-term safe instruments like government securities, treasury bills, certificates of deposit, commercial paper, and inter-bank call money.
Since there isn’t much volatility, these funds are suitable for investors who want to park money for short-term and earn better returns compared to savings bank accounts.
Advantages of Investing in Mutual Funds
There are over 8000 mutual funds in different categories to meet the objectives of all types of investors. The right mix of growth, income, and safety makes mutual funds suitable for everyone.
Following are the advantages of investing in mutual funds:
1. Expert Money Management
Your pooled money is managed by a team of experts. So, you have the advantage of expert guidance in creating wealth. The fund manager does meticulous research in deciding equities, sectors, allocation, and of course the buy and sell.
2. Low Cost
If you calculate the benefits of expertise, diversity, and other options of return, then mutual funds are definitely a very cost-effective instrument of investment.
There is a regulatory cap of 2.5% on the expense ratio.
3. SIP Option
Systematic Investment Plan gives you the flexibility to invest at an agreed interval which could be weekly, monthly, quarterly. You can start investing in mutual funds with an amount as low as Rs. 500.
4. Switch Funds
If you are not happy with the performance of a particular mutual fund scheme, then some mutual funds do offer you an option to switch funds. However, you need to be very cautious while opting to switch.
Mutual funds offer you the benefit of diversification in such asset class which otherwise isn’t possible for an individual investor. You reap the dividend of maximum exposure with minimum risk.
6. Ease of Investing and Redemption
Now, it is pretty easy to buy, sell, and redeem fund units at NAV. Just place the redemption request and you will get your money in the desired bank account within a few days.
7. Tax Benefit
Under the ELSS, tax-saving mutual fund you have the double benefit of tax saving and wealth creation. Under Section 80C of the Income Tax Act, you can have a deduction of a maximum of Rs. 1,50,000 a year.
8. Lock-in Period
Close-ended mutual funds have a lock-in period, meaning as an investor you are not allowed to redeem the fund before a certain period.
You get benefits in terms of long-term capital gain tax.
Ways to Invest in Mutual Funds
Thanks to the fast adoption of internet technology, now your MF units are just a few clicks away. Depending on your resources, you have several options to start investing in mutual funds. Following are some ways to invest in mutual funds:
1. Direct Investment
You can visit the branch of the concerned mutual fund company and deposit the duly filled form. Alternately, you can download the form and fill it carefully.
You should read the document carefully before handing over the cheque.
2. Online Mutual Fund Investment Platform
For investing online, all you need is your mobile phone and internet connection. There are several platforms that help you in choosing the right mutual fund based on defined objectives, risk appetite, and other factors.
Scripbox is an online investment platform that helps you save your time and energy. The step-by-step process from selection to payment and redemption makes it simple for even a beginner to start investing without any assistance.
Thus, all you need is your PAN Card details, Identity details, and an active bank account to link with the mutual fund house.
3. Using a Demat Account
For investing, you need to 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 fund in which you want to invest. Then you need to complete the investment by transferring the amount online.
4. Through Karvy and CAMS
You can invest online and offline in funds through registrars like Karvy and CAMS.
In Online Method – You need to visit the website of CAMS or Karvy, create an account, provide folio number, select the scheme and make payment.
In Offline Method – You can invest by visiting the local office and complete the application form, hand over the cancelled cheque and also a copy of KYC documents.
5. Mutual Fund Agents
Investing through agents is a time consuming and costly method that should be avoided. You can call an agent to help you choose and fill the requisite form. Nowadays, agents come with digital devices to help you fill form digitally and activate your account instantly.
However, you should make sure that the agent is genuine. Some agents may charge a commission for services.
How to Invest in Mutual Funds Through Scripbox
Mutual fund investment through Scripbox is a quick, paperless and hassle-free experience. Following are the steps to invest;
Step 1 – Visit Scripbox and Get Started
Click the box “Let’s Get Started” on the Scripbox home page. The page will scroll down to show you different objectives.
Mutual fund schemes fulfill most of the financial objectives. You can pick the objective that aligns with your financial needs.
For example, we have taken “Start a SIP” to invest in the best equity and debt mutual funds.
Step 2 – Create a Plan
Here you will be prompted to create a plan for investing in the mutual funds.
Provide investment amount and number of years to create a plan. The hypothetical example shows a SIP of Rs. 8000 and 10 years as the stay invested period.
Click on “Create a plan” to proceed.
Step 3 – Choose Between “Long Term Wealth” and “Short Term Money”
Scripbox gives you two options to build wealth. You have the option to pick one of them.
Long Term Wealth – The plan invests in risky equity and is for aggressive investors.
Short Term Money – The plan invests in safe debt & money market instruments and is for risk-averse investors.
The example has selected the “Long Term Wealth” option. Where you will get plan details indicating the best mutual funds and the expected returns.
Click on “Continue” to proceed with fund investment.
Step 4 – Account Creation and Login
Create an account for investing through Scripbox. You will need an email ID and password for creating an account.
You can also create the account using your Facebook or Google account.
Step 5 – Plan Confirmation
When you log-in you will get the plan as shown below.
Click on “See Recommended Funds” to proceed with mutual fund investment. Next, you will the list of algorithmically selected best mutual funds and investment amount.
You can either go with the selection or can change the funds and the amount. For that, you need to click “I Want to change funds/amount”.
Click the tab “Next” to proceed with payment.
Step 6 – Bank Details and Money Transfer
You need to provide Bank account and PAN details necessary for investment. Also, the account will be used for investment and crediting the redemption amount by the mutual fund houses directly into your specified bank account.
A mutual fund is a powerful investment option that has the potential to generate long-term wealth for investors. Also, mutual funds have schemes for all types of life goals, right from creating a pool of wealth to retirement. You have schemes for risk-averse and conservative investors.
The option has benefits of diversification, low cost, flexibility to invest in smaller amounts and professional fund management.
Furthermore, combined with online investment platform you have a great tool that makes mutual funds investing a quick and hassle-free experience.
Explore our article on factors affecting the mutual funds performance
Frequently Asked Questions
A mutual fund is a financial instrument that pools money from different investors. The pooled money is then invested in securities like stocks of listed companies, government bonds, corporate bonds, and money market instruments. The expert and professional fund management help investors outperform the returns of traditional investment vehicles like bank savings accounts and fixed deposits.
Mutual funds are definitely a very good investment option for investors who are looking for a diversified investment. Investors who do not have the time and expertise to shortlist, invest and track their investments can consider investing in funds. Mutual funds are managed by professional experts who dedicate their time to build a portfolio of different asset classes. Moreover, one can start their investment through small amounts. Also, they can regularly invest through SIPs and develop disciplined investment habits. Mutual funds do not have any lock-in period, and hence the redemption process is hassle-free.
Furthermore, mutual funds offer a variety of schemes that suit a diverse range of investors. In other words, investors who seek to get equity exposure can invest in equity funds. While investors who like to limit their equity exposure can either invest in debt funds or hybrid funds.
Therefore, mutual funds are for everyone who wishes to start their investment journey with the help of professional fund managers. They are also suitable for investors who lack time to manage their investments. Moreover, the returns from funds in the long term have been promising for its investors.
Mutual fund investments are subject to market risks. In other words, mutual fund investments are market-linked and hence are subject to market volatility. Therefore, no mutual fund is 100% safe. However, mutual funds are regulated by the Securities Exchange and Board of India (SEBI), and default risk is nil. Mutual funds have varying levels of volatility. In other words, equity funds majorly invest in equities and are highly volatile to the changing market dynamics. On the other hand, debt mutual funds invest across different debt instruments issued by the government and corporates and hence are comparatively less volatile than equity mutual funds.
Unlike bank deposits or government bonds, mutual funds do not guarantee returns. Moreover, in the long term, mutual funds have the capacity to earn high returns in comparison to traditional investment options. Therefore, investors who understand the markets and have the capacity to undertake some volatility can invest in mutual funds.
The Securities Exchange and Board of India (SEBI) is the regulatory body for mutual funds. SEBI strives to protect investor interests. The Association of Mutual Funds in India (AMFI) is association of all the Asset Management Companies of SEBI-registered mutual funds in India. It also ensures best business practices and code of conduct and represents SEBI, RBI, and the Government of India on all matters concerning the mutual fund industry.