What is a mutual fund, how it works and what is the benefits of Mutual Fund Investment? What is a unit, information about mutual funds, how to invest in it, and how it is considered as a more secure investment rather than directly investing in the stock market?
Most people are afraid to hear mutual funds or other financial jargon like this. If you look at it closely, understanding Mutual Fund is not that difficult. Therefore, to explain this, it is important to answer a basic question of what is a mutual fund?
What is a Mutual Fund?
Mutual Fund is a collective savings fund prepared by many investors’ contributions. A Mutual fund is invested in assets of one or more class like equity, debt (debt) and liquid assets, etc. It is called a mutual fund because all the risks, rewards, gains or losses associated with or generated from this collective savings fund are shared by all investors in proportion to their contributions.
A mutual fund is basically a trust with a sponsor (AMC in this Case). They are registered with SEBI (Securities Exchange Board of India), which approves the asset management company (AMC) that manages the fund. AMC comes under the purview of trustees who have to ensure compliance with fund regulations.
What is a unit?
When many investors invest in a fund together, the fund is divided into equal parts called a unit.
For example, suppose some friends want to buy a piece of land. The price of a piece of land of hundred square yards is one lakh rupees. Now if you divide this fund into units of ten rupees then 10,000 units will be created. Investors can buy as many units as they want, according to their investment capacity. If you have only one thousand rupees for investment, then you can buy a hundred units. In the same proportion, you also become the owner of that investment (land).
Suppose that the value of this one lakh investment increased after one month to Rs 1,20,000. Now, according to this investment, the unit price will be deducted, then the unit of ten rupees is now twelve rupees. The investor who bought a hundred units in one thousand rupees, according to twelve rupees per unit, now his investment (100×12) has been Rs. 1200.
Based on the amount invested by you as an investor, they are allocated unit by the Fund. Therefore, an investor can also be known as a unitholder. In addition to the other income earned from this, the increase in the value of the investment is divided into the proportion of the expenditure, the burden and the reduction of taxes, with the number of units divided by the investors/unit holders
Who should Invest into Mutual Fund?
With this, you can see that an investor who can not make big investments, has the facility of investing in small units.
Apart from this, the biggest benefit of mutual funds is that an investor who does not have much information about the market can leave his investment in the hands of experts. These experts determine where, how and when to invest.
How to choose the appropriate category of mutual funds?
Your fund selection should be based on your risk taking ability and the expected return. If you can take more risks with higher returns, you can choose an equity-based fund, but if you are not comfortable with the risk, choose a debt fund.
Ratings are determined on the basis of many factors. Mutual Funds are rated based on many factors such as Growth, Investment across sectors, the performance of the fund relative to the Category. Always check the rating of the mutual fund to select the best Mutual Fund for Investment.
The total market value (after taking all expansions related to the fund) of all the shares included in the NAV or Net Asset Value, which is divided by the number of available units.
NAV of a mutual fund is funded by loss and gain. Whenever the fund’s profit increases, net asset value units increase without any change, thus it determines whether there is any benefit on the investment or not.
- Expense Ratio:
Expense ratio can be defined as: Total operating expense is arrived by dividing it from the Total Value of Asset Under Management (AMU).
AUM is the total market value of the property, which manages the investment or financial institution on behalf of the company or the firm.
- Entry Load:
When an investor invests in a mutual fund, the entry load charge is taken. This is the percentage added in the NAV at the time of the investment.
- Exit Load:
The exit load is charged on the date of redemption, and its value depends on the fund-to-fund. Sales tax deducted in the form of sales charge, exit, and entry load is added directly to AMC, not in the mutual fund.
- AMC (Asset Management Company):
It is a short form of Assets Management Company – a company that runs a mutual fund. For example, HDFC Mutual Funds are ICICI Prudential Mutual Funds. Here is the list of AMCs. Top AMCs have good and professional fund managers.
- AUM (Asset Under Management):
It is the Total Fund Investment of Assets Under Management Mutual Fund Plan.
You can compare your returns. Ultimate benchmark is Sensex and Nifty. Best way to analyze a Mutual Fund Investment is to compare the returns of fund from its peers.
For Example: Compare the performance of a Large Cap fund with other Large Cap Fund to take the decision of whether to pull the plug on the Mutual Fund Investment or not.
Comparing returns of Mutual funds of two difference category is not the correct way to evaluate the performance.
- Fund Manager:
A fund manager is a person who is entrusted with the job of Investing Mutual Fund Investors money into a financial product such as Government Securities and stock across various sectors depending upon the category of Mutual fund.
The performance of a mutual fund is largely dependent on its fund manager.
Below is the list of Glossary of Mutual Fund Investment:
Holdings are nothing but places where Investors money is invested by the Fund Manager. These are the names of companies whose shares or bonds are purchased. You can easily access Holding of each and every mutual fund by visiting that AMC’s website.
Return investment is loss or profit. It basically changes with the value/principal amounts. In a mutual fund, we usually check the returns of 1 y, 3 y, and 5 y.
Keep reading below on what is the ideal time period to evaluate Mutual Fund investment.
This is the time period in which previously invested money cannot be withdrawn. Tax-Saving Mutual Fund (ELSS) has a lock-in of 3 years.
Risk is usually in uncertainty in investment. This is a deviation from Standard or Expected Value. Each mutual fund rate the associated risk based on its asset allocation.
Fund Category Ideal Investment tenure Expected Returns
ELSS Fund 5 years and more(Mandatory 3 years) 15-20%
Large Cap Fund Minimum 5 to 7 years 12-15%
Mid Cap Fund Minimum 7 to 10 years 15-20%
Small Cap Fund Minimum 7 to 10 years 15-20%
Multi Cap Fund Minimum 6 to 7 years 15-20%
Sector Fund Variable as sector might give better returns in short term as well Variable
Index Fund Depends upon Index Variable
Liquid Fund Few day to weeks to month to years 7-9%
Ultra Short term Fund Maximum 6 months to 1 year 6-9%
Short term funds Maximum 1 to 3 years 5-9%
Monthly Income Plan Variable 7-10%
Gilt Fund Minimum 1 year 8-10%
Income Fund Maximum 1 to 3 years 8-10%
Debt Oriented Hybrid Funds Maximum 2 to 3 years 8-12%
Equity Orented Hybrid Fund Maximum 2 to 5 years 10-15%
Hence, the past performance of any mutual fund doesn’t guarantee anything in the future.
How to calculate returns of mutual funds?
Returns of a mutual fund are calculated based on its prevailing NA asset value (NAV). Suppose that when you invested Rs 10,000 then the fund’s NAV was Rs 10 and you had 1,000 units. If NAV increases to 12 then your investment will increase from Rs. 10,000 to Rs. 12 thousand.
- MFs offer higher interest rates than FD and RD
- In the long run, returns of mutual funds can range from 10% to 40%.
What is the SIP (Systematic Investment Plan)?
Systematic Investment Plan or SIP is a sensible, hassle-free way to invest money in mutual funds. With SIP, you can invest a fixed, predetermined amount on regular intervals (weekly, monthly, quarterly, etc.) SIP is an employed method of investment and helps you adopt the habit of saving and creating wealth for the future.
With the help of Systematic Investment Plan, people can avail advantage of Rupee Cost Averaging by investing a small amount of money on a regular basis. This is an option for those who can not put huge amounts together, so it is an attractive product for investors with different income levels. Mutual funds also accept an initial investment of as small as Rs 500.
Important Fact to know about Mutual Funds Investment?
Everyone should understand that return on your investment depends on market conditions. You should adopt a long term systematic investment plan to minimize risk and get higher returns. It is good to review the investment plan from time to time and make adjustments accordingly.
Who can invest in Mutual Funds in India?
Mutual funds are open to various types of investors. Including resident individuals, NRIs, PIOs, HUFs, companies, partnership establishments, trusts, co-operatives, banking, and non-banking financial institutions, registered FIIs, QFIs, etc. This is not a complete list, but it includes the most common type of investors of mutual funds in India.
Mutual funds are divided on the basis of their maturity period:
- Open-ended Fund: No fixed maturity period, you can invest or withdraw at any time
- Close-ended fund: The duration is fixed and the person can invest in the specified period only.
- Interval Fund: These are the combination of open and close-ended funds.
The types of mutual funds available in India are as follows:
A stock fund or equity fund is a fund that invests in stock, also called equity security. Stock funds, bond funds, and money are different from the fund. Contrary to bonds, notes or other securities, the assets of the equity fund are primarily in stock, a small amount is in cash which is an extremely small percentage of the total fund. Hence, As Equity Mutual Fund Investment carry most risk out of all Mutual Fund types as they invest at least 65% of total money into direct equities.
Debt fund is a collective investment fund, such as a mutual fund or exchange-traded fund, whose main holding is in fixed income investment. Debt funds can invest in short-term or long-term bonds, securitized products, money market ventures or transit rates (debt). Debt Fund carries less risk out of all Mutual Funds.
Balanced funds have been created keeping in mind the investors who are looking for a combination of security, income, and average capital appreciation. Balanced Fund invests corpus between Debt and Equity product in a ratio like 60:40.
- Index fund
An index fund is a type of mutual fund whose portfolio is created to match or track a market index such as the Nifty, Bank Nifty and Nifty IT, etc.
Since Index funds mimic the holding of a Particular Index, it falls under the category of Passive Mutual Fund. In this fund, Fund manager decides to sell and buy stock base on the underlying index composition.
Unlike Actively managed mutual funds, fund managers of Index fund to don’t have the luxury to identify and research stock.
- Fund of Funds:
“Fund of Funds” is an investment strategy in which a portfolio of other investment funds is maintained rather than directly investing in stocks, bonds or other securities.
This type of investment is often called a multi-manager investment.
- Money Market Fund / Liquid Fund
Liquidity Funds are common debt mutual funds that invest your money in short-term market enterprises such as Treasury (fiscal) bills, government securities and call money (the available funds on demand), which have the least risk.
This fund can invest in the maturity period of up to 91 days. In most cases, the maturity period is much lesser.
- Credit fund
Credit fund is a type of debt mutual fund scheme that invests in higher risk corporate bonds to gain higher interest rates. Unlike the top-rated bonds, fund managers typically invest in securities with ratings ranging from AA-, A +, A-, BBB, etc.
- Tax-saving fund
These funds also are known as ELSS fund (Equity Linked Saving Scheme) invests primarily in equity shares. The investments made in these funds are eligible for deduction under the Income Tax Act.
These are considered to be a high-risk fund, but if the fund performs well then there are more returns. ELSS funds have a lock-in period of 3 years.
Mutual funds have become one of the most popular investment options in India, and this trend is still going on, new funds and schemes are coming in the market continuously. Here are some of the main reasons why people invest in mutual funds.
- Professional management
The mutual fund is managed by fund managers of asset management companies. These managers reduce their risks and maximize returns by using their investment expertise. In the absence of financial information, investors often find it difficult to decide which Mutual Fund they put in their savings.
- Diversification of risks
Since the funds invest in many securities, the risk becomes diversified. There is less chance that all the stocks together will perform poorly. Some losses on the stock are compensated by the profit on others. This greatly reduces the risk.
- Affordable investment options
Mutual funds are a cost-effective investment option for those who do not have the right amount to invest directly in other ventures, which require an equity or more initial investment. Also, transaction costs are distributed to all investors, this reduces personnel costs.
- Focused investment
All mutual fund schemes explicitly specify which assets are their targets for investment, so investors can give direction to their savings in a systematic and focused manner. It also gives investors access to certain securities which are otherwise unavailable to them, such as foreign sectors or foreign securities in which individual investors can not invest.
- Substitute options
There are several types of funds available such as equity funds, debt funds, money market funds, hybrid funds, sector funds, regional funds, fund of funds, index funds, etc., which gives investors a lot of options.
- Easy to buy and redeem
Fund units can be easily bought and sold on the prevailing unit price or NAV. It is easy for the investors to invest and withdraw money in the fund so that they get liquidity. The only Exception to this is ELSS Mutual Funds which have a lock-in period of 3 years.
- Tax benefits
Many fund/schemes are designed to work as tax-saving enterprises, such as ELSS (Equity Linked Savings Scheme). Investments made in these schemes are eligible for income tax exemption.
- More returns
Mutual funds get good returns on medium and long term investments because investors can increase overall returns by diversifying the risk.
- Regulated investment
All funds come under the purview of SEBI (Securities Exchange Board of India), which ensures that all transactions are in accordance with the regulations. This protects the Mutual Fund investment of the Investor.
- Easy tracking
Investment can be difficult to review for retail investors regularly. Mutual funds provide a clear explanation of all investments, making it easy for investors to keep an eye on them. Hybrid or balanced funds allow investors to use both equity and debt funds at the same time, in their desired ratio.
- Flexibility through fund switching
Many funds offer investors flexibility by allowing investors to switch between schemes or funds for better duration/rules and/or better returns.
- How to choose the best mutual fund?
When choosing the best fund for you, you should follow a fixed and organized process keeping in mind your financial goals.
Also, you should complete the asset allocation work before choosing the scheme. For example, the largest portion of the client’s low-risk equity will be of the Large Cap Fund. As the risk-taking capacity increases, mid-cap and small-cap funds can be considered.
How do new people invest in mutual funds?
Mutual funds are in easy reach of investors. For which applications can be made from the following methods.
How to Invest in a Mutual Fund for beginners – multiple ways?
These are professionals who are trained to contact the customer to give information about various funds of a company. They help in the processing of applications and related tasks such as unit redemption, canceling, transferring and other behaviors with the company. The agent’s commission, usually up to 6%, is added to the fund’s purchase price.
Bypassing client agents, they can apply in the scheme themselves. For this, they can go to the nearest office of the mutual fund company or use the online facility.
Forms can be collected from the appropriate office or downloaded from the company’s website and deposited in the office. Alternatively, the application can also be processed online.
Mutual funds are going to be invested. Take care of these things, know which fund is best for you.
Choosing the right type of mutual fund is the first step towards making the property. Due to the availability of many fund categories and plenty of options, you may be confused about the decision. All funds are seen to be an identical and attractive sight.
However, if a fund meets your friend’s financial needs then it is not necessary that it is also suitable for you. But because of being confused you should not stop looking at the prospects of a mutual fund. Rather than fear the available options, you have to do introspection to find only the fund that is best for you.
Broadly, mutual funds can be divided into three categories i.e. equity, debt, and hybrid. Each category is to meet a specific goal.
Apart from this, each fund has different implications for the investor.
You only have to find answers to these three basic questions to get into the right category of fund.
What is my financial goal?
Investment should always be consistent with the goal. Before choosing a mutual fund, you have to ask yourself “what is my basic objective behind investing in mutual funds?”.
An investor can use mutual funds to meet various financial goals. The most popular goals for which investors use mutual funds include planning for retirement, making emergency funds, going on vacations, buying house/car, financial needs of children’s higher education.
If you look closely, then each goal requires a different amount of achievement. Accordingly, the return rate will be different for depositing this kind of corpus.
If you want a big corpus to buy a home in the future, then equity funds will be more suitable than a debt fund. Equity funds offer higher returns for long periods than loans / hybrid funds.
Similarly, if you want to create an emergency fund, it will be the closest goal. In addition, the amount required to achieve this will be less than the amount required to buy the house. Here, your objective will be to protect the investment on high returns. Because of this, you can easily invest in a debt fund, which will give you better returns than keeping your money in Savings Bank Account.
How much risk can I take?
Taking risks means “how much investor funds can bear in value”. It can also be considered to be risk tolerant of a person. It involves the willingness to take risks and its potential. Desire is a practical aspect, whereas capacity is linked to the financial aspect.
You may be willing to take risks, but if you do not have the capacity to take it, then it does not tolerate your risk. Apart from this, the risk tolerance of one person varies with age and stage of life.
Under ideal conditions, young investors are more tolerant of risks than middle-aged investors. Likewise, if a young person who is not dependent on a person who is dependent on some people, risk tolerance will be less.
The fund selection ultimately depends on your risk tolerance. There are roughly three investor categories based on risk tolerance – i.e. protectionist, moderate and aggressive Loans funds for protectionist investors are suitable investment instruments which offer moderate returns with capital protection.
Aggressive investors can choose equity funds and related sub-categories which offer high returns at high risk. Those who take relatively low risks want to explore the stock market with comparatively low risk, they can put money in hybrid / balanced funds.
What is my investment scenario?
The investment scenario is related to that time period for which an investor likes to invest in mutual funds. It depends on the investor’s goals. An investment scenario can be short-term, intermediate and long-term. Goals that can be acquired within 1 to 3 years, which are classified as short-term goals. Goals that require 3 to 7 years are classified under intermediate goals.
However, the targets that require more than 7 years, such as retirement planning or home buying, are classified under long-term goals.
The choice of mutual funds varies according to your investment scenario. Loan funds such as liquidity funds are suitable for achieving short-term goals.
Balanced / Hybrid Funds are more suitable for intermediate goals like buying a car. Long-term goals such as retirement planning can be achieved with the help of an equity fund.
Applying for a Mutual Fund online :
The popularity of online transactions is increasing steadily for several reasons, which are as follows. The person can apply in schemes from his own office or home comfortably.
Apart from the company’s websites, there are also many online financial services providers who work on a single-point portal to look at and compare the funds and schemes of many companies.
Bypassing the agents, the investment becomes cheaper because the commission is not connected to the cost of purchase.
All necessary information, which includes brochures and other materials, is available online for the reader of the investor. This can save investors from unfair sale by agents and make informed and independent decisions.
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What is Investor’s Choice?
In recent times, mutual funds have emerged as an alternative to stocks and many people are investing more and more money.
The main reason for this is that investing in mutual funds is easy and investing in mutual funds through SIP is becoming more and more people’s choice.
Mutual funds are a very good option for investing where interest is banks are getting reduced almost every single year. If invested for a long time, then it can be the solution to get the highest return on investment.
What are the benefits of investing in mutual funds?
Most of us are afraid of the mere management of our own investment.
This facility with the management company is that they assign workload to the right people to execute various actions based on their education, experience, and skills.
Professional fund management is the best advantage of mutual funds.
Whatever fund you can choose, remember that the fund returns are not guaranteed. They are subject to market risk and returns may vary over time.