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When anybody talks about investing one’s money, it is always difficult to decide “WHERE TO”, especially if the person is new to the finance sector. However, it is beneficial to keep his/her money (at least some portion) in Mutual Funds. For anyone, mutual funds offer a effective and accessible way to start growing wealth. Furthermore, through mutual fund one can get the benefit of inflation beating returns (XIRR, CAGR or Absolute Return) and can enjoy the magic of compounding.
In this beginner’s guide, we’ll demystify mutual funds, explaining, What are Mutual Funds, how they work, and why they might be an excellent choice for an individual’s investment portfolio.
What are Mutual Funds
Mutual fund is an investment tool in which funds from investors are pooled and invested in equities, bonds, government securities, gold, and other assets. Companies that qualify to set up mutual funds, create Asset Management Company (AMC) or Fund Houses, which pool in the money from different investors, and invest in different asset classes.
The people responsible to manage these mutual funds are known as fund managers, who have the expertise in analyzing and managing investments. The funds collected from investors are invested in different financial assets such as stocks, bonds, and other assets, as defined by the fund’s investment objective by fund managers. Fund managers take care of decisions such as Where and when to invest, and many other responsibilities. Expense ratio, is a fee that AMC charges for the fund’s management, from the investor. It is not a fixed fee and varies from time to time and from one mutual fund to another.
Why to choose Mutual Funds?
- Professional Management
Decisions were taken by experienced fund managers on behalf of mutual fund investors. These professionals analyze market trends, research potential investments, and actively manage the fund’s portfolio to optimize returns. Their expertise can be especially beneficial for beginners who may not have the time or knowledge to manage their investments actively.
- Accessibility
An individual doesn’t need a large sum of money to invest in mutual funds. Most mutual funds have relatively low minimum investment requirements, making them accessible to a wide range of investors. Through mutual fund one can invest in stock market with a low sum of money.
- Liquidity
Mutual fund are generally highly liquid investments. This means you can easily buy or sell your mutual fund units on any business day at the fund’s net asset value (NAV). This liquidity feature makes it convenient to access your money when you need it.
- Diversification
As a Wiseman said, “Don’t put all your eggs in one basket.” This proverb scenario fits perfectly in case of mutual fund. One of the most important advantages of mutual funds is diversification. Diversifying your investments means spreading your money across various assets, reducing the risk associated with any single investment. Mutual funds do this automatically by investing in a range of securities, making them less vulnerable to market fluctuations.
Types Of Mutual Funds
- Equity Funds
Mutual funds that primarily invest in stocks, mainly aiming for capital appreciation over the long term comes under this category. These includes funds from sub categories like large-cap, mid-cap, or small-cap funds, depending on the size of the companies in which they invest.
- Bond Funds
These funds invest in securities like government and corporate bonds (fixed-income securities). They offer regular interest income and are generally considered less risky than equity funds
- Money Market Funds
Money market funds invest in short-term, highly liquid securities like Treasury bills and certificates of deposit. They are known for stability and low risk, making them suitable for preserving capital
- Balanced Funds
Also known as hybrid funds, these combine both stocks and bonds in their portfolios to achieve a balance between growth and income. They provide diversification and are often considered a middle-ground option for investors. These are Ideally suitable for moderate risk taking investors that want capital appreciation (equity exposure) also.
How Mutual Fund work?
- Investment Objective
Based on the category to which it belongs, each mutual fund has a specific investment objective, investment methodology and approach such as growth, income, or a combination of both. One should understand this objective and based on relevance, fund should be selected.
- Fund Manager
The people responsible to manage mutual funds are known as fund managers, who have the expertise in analyzing and managing investments. The fund managers invest the funds collected from investors in mutual funds, in different financial assets such as bonds, stocks, and other assets, inline with the fund’s investment objective.
- Diversification
One of the most important benefit of mutual funds is diversification. Diversifying your investments means spreading your money across various assets, reducing the risk associated with any single investment. Mutual funds do this automatically by investing in a range of securities, making them less vulnerable to market fluctuations. The fund manager creates a diversified portfolio of assets to align with the fund’s objectives.
- NAV Calculation
The Net Asset Value (NAV) represents the fund’s per-share market value and is calculated daily. Based on the stock market fluctuations NAV of a mutual fund also fluctuates. NAV denoted the performance of a mutual fund scheme. NAV per unit can be explained as, “The market value of securities of a scheme divided by the total number of units of the scheme on a given date”.
- Buying Shares
Investors can buy shares of the mutual fund directly from the fund company or through a brokerage account. These are called units. Based on the stock market fluctuations NAV of a mutual fund also fluctuates. Unit cost of mutual fund changes based on the change in NAV of that fund.
- Redeeming Shares
Investors can sell their units back to the fund at the current ongoing NAV. This means one can easily buy or sell mutual fund units on any business day at the fund’s net asset value (NAV). Mutual fund are generally highly liquid investments. This liquidity feature makes it convenient to access your money when you need it.
- Fees and Expenses
Mutual funds may charge fees, including management fees and operating expenses. For the fund’s management, the mutual fund AMC charges a fee to the investor known as the expense ratio. It is not a fixed fee and varies from time to time and from one mutual fund to another. One should asses and be sure to understand these costs before investing.
Risk Associated with Mutual Funds
While mutual funds offer many benefits, they are not entirely risk-free. Common risks include:
- Market Risk: As the money invested in mutual fund eventually get invested in different asset classes (for example: equity), The value of your investments can fluctuate with market conditions. Hence one should select a mutual fund based on its risk profile and investment horizon, as these investments can show volatility on short term.
- Managerial Risk: As the performance of the fund depends on the skill of the fund manager. Hence the capability of fund manager matters the most for a fund performance. Decision of fund manager impact the fund performance most and thus it is very much of importance to assess the background, work experience and working ability of associated fund manager while choosing a particular fund.
- Fees: Although expense ratios and other fees that are being charged by a particular fund, does not looks highly impacting in a short span, however, these high fees (in percentage terms) can eat into your returns over time.
- Redemption Fees: These are also called exit load. Some funds charge fees for selling shares shortly after purchase. These also will take some of your earned money, if you exit/sell your units before a pre-defined time period.
Tax Consequences: Finally, mutual funds are also taxable. Capital appreciation/Gains in mutual funds can have tax implications. Different kinds of Short term/Long term Capital Gain taxes are there which implies on the gains earned through mutual funds.
Here presenting a short video for your ease of understanding:
How to get started
- Set Clear Goals: While investing into mutual funds it is very important to have investment objectives, risk tolerance, and time horizon. Based on the nature of these pre-defined goals only, the kind of mutual fund should be selected.
- Research Funds: Based on the category selected, further independent research is of utmost importance to explore different mutual funds to find those that align with investment goals.
- Open an Account: To start investing in Mutual Fund one should have a platform that provides facility to invest and manage the investment. For this, we need to choose a brokerage or fund company, open an account, and start investing. All these brokerage companies also offer their apps for the ease of investing and tracking. Click here to see the best/top Mutual Fund Investment apps in india.
- Monitor Your investments: All investments done are need to be monitored on appropriate frequencies. This requires regular review of one’s mutual fund holdings and make adjustments as needed.
- Seek Professional Advice: If required, one should consider consulting a financial advisor for personalized guidance.
Conclusion
Mutual funds can be a valuable addition to your investment strategy, offering diversification, professional management, and accessibility. By understanding the basics of mutual funds and conducting thorough research, you can make informed decisions to help you achieve your financial goals. Remember that all investments carry some level of risk, so it’s essential to invest wisely and stay informed about your portfolio. Further, it is always beneficial to take some professional advice from a well-recognized/licensed financial analysts instead of believing on market tips. Hope this article, “What are Mutual Funds and their types will give the required information as desired.
