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What is Mutual Fund?

A mutual fund is an investment scheme which is professionally managed by an Asset Management Company. The asset management company clubs the investment of group of people in one fund and invests their money in equities, securities, and bonds.

An investor can buy mutual funds units which will represent his share in the particular scheme. The units are bought and sold on the basis of NAV (Net Asset Value) which is updated daily by the mutual fund house. As per the mutual fund holding, the NAV keeps changing due to the volatile market conditions.

Every mutual fund house has to register their fund with SEBI. To protect the interest of every investor, SEBI has laid down strict rules for the mutual fund houses to follow. The mutual fund gives an investor access to a diverse portfolio of bonds, securities, and equities even for a small amount of investment which is not possible otherwise. Mutual funds are strategical investments which have been known for giving lucrative returns to the investors over the past decade or so.

Types of Mutual Funds – The Basics

  • Equity Funds: Primarily, these mutual funds invest in stocks. These funds can be actively or passively (index fund) managed. These mutual fund investments offer high returns over a longer period of time. As a result, they are accompanied by high risks. Equity funds are also known as stock funds.

  • Debt Funds: Here, the investments are made in debt instruments like government securities, corporate bonds, debentures, etc. They are less risky as compared to equity mutual funds. This implies that the returns are not as high as that of equity mutual funds, but they act as a reliable and steady source of income.

  • Money Market Funds: These invest in highly liquid money market investment instruments like certificate of deposits, treasury bills, commercial papers, etc. These enable high liquidity as these investments are made for a short duration of 15 days.

  • Balanced or Hybrid Funds: These mutual funds are for medium and long term investors with a moderate risk appetite. As the name suggests, these mutual funds maintain a balanced portfolio by investing in a mix of risky investment like equity funds, and non-risky investments like debt funds. This helps in minimizing the risk exposure of the mutual fund portfolio, while aiming at growth and serving as a stable source of income.

  • Fund of Funds: These mutual funds aim at achieving diversification of the portfolio for capital growth while controlling risk, similar to balanced mutual funds.

  • Sector Funds: As evident from the name, these funds invest in equity shares of organizations of a particular industry or sector. They generate higher returns as compared to diversified funds and, therefore, are riskier.

  • Index Funds: As suggested by the name, the investment method for this mutual fund is similar to that of an individual investing in leading stock market index. As the fund value is linked to the benchmark index, the NAV fluctuates along with index movements.

  • ELSS Tax-saving Funds: ELSS or Equity Linked Saving Scheme funds offer tax benefits as per Section 80C of the Income Tax Act, 1961. Such a scheme enables investors to invest through easy monthly instalments as well as one-time lump sum investment. It serves the dual purpose of investment and savings.

Types of Mutual Funds Based on Structure

Lump sum mutual fund investment

For these mutual funds, investors have to pay the entire investment amount at one go, at the time of purchasing the mutual fund scheme.

Systematic Investment Plan (SIP)

As opposed to lump sum investment, investors can pay the investment amount in easy instalments every month.

Open-ended Mutual Funds

Open ended funds can be purchased and repurchased on a continuous basis. These funds do not have a maturity period. The funds can be bought and sold on a daily basis by investors based on the NAV (Net Asset Value).

Close-ended Mutual Funds

Unlike the open ended funds, close ended funds have fixed maturity period, for example between 5 to 7 years. The funds are open for subscription only during the stipulated period at the time of the launch of the scheme.

Interval Funds

These funds are a combination of both open-ended and close-ended mutual fund schemes. The units of these funds are open for sale or redemption only during the pre-determined intervals at NAV related prices.

Structure of a Mutual Fund

Board of Trustees

Every mutual fund company has a management team that consists of Board of trustees and a CEO. The responsibility of the management team is to carry out operations in interest of the shareholders. The core responsibility of the Board of Trustees is to handle and look after the administrative matters. The trustees are appointed by the sponsor. The board selects the types of funds that the trust will offer to the public. The trust hires the investment advisor, custodian and transfer agent for every fund.

Sponsor

The main person who establishes a mutual fund is known as a promoter of a mutual fund or more commonly as a sponsor. The sponsor is supposed to contribute around 40% or more of the net worth.. A sponsor can be a person or a financial institution or a corporate house or a bank who has a 5-year track record in the financial services business and must have made profit in at least 3 out of the 5 years.

Custodian

The custodian looks after the investments made. He maintains the custody of all the shares and various other securities bought. The securities purchased by the company are kept in possession of the custodian. The custodian is responsible for safekeeping the assets at all times and ensures the withdrawal is done as per the SEBI rules.

Asset Management Company (AMC)

The Asset Management Company is the investment manager of the trust who does appropriate investments in securities as per the fund’s portfolio and the administrative functions of the mutual fund. The investment advisor is also known as the fund manager of the Mutual Fund. The AMC consists of the Chief Investment Officer, the fund managers and analysts who manage the various schemes launched. The fund manager gets a management fee which is usually a percentage of the fund’s value plus bonus if he/she performs well and makes good profit on the fund’s investment.

Registrar and Transfer Agent (RTA)

The Registrar and Transfer agents manage, maintain and update all the investment and investor-related records like processing the applications for purchase and redeem or cancel the fund shares, look after the distribution of dividend to investors. The transfer agent gets a fee for the services rendered.

Brokers / Dealers

Brokers / Dealers buy the shares and sell securities on the stock exchange for the AMC. Dealers also give valuable research reports and outlook on the markets to the Fund Manager.

Mutual Fund Based on Geography

Equity Funds

Equities are one of the more preferred choices of mutual fund amongst the retail investors. The money invested in the shares of the companies are called equities. There is a high risk involved in the short term but the investment can be lucrative and beneficial for the investor in the long term.

Debt Funds/Fixed-Income Funds

The funds that get invested in rated debts like government securities, debentures, corporate bonds and other money market financial instruments are known as debt funds. These investments are considered to be less risky compared to equities. Debt funds are ideal for the investors who want regular and steady income from their mutual fund investment.

Hybrid funds / Balanced Funds

These funds keep a balance of risk in their portfolio by investing in debt as well as equity. The fund's goal is to provide both growth and regular income to the investor. Hybrid or balanced mutual funds are ideal for investors who want to play safe and don't want to take much risk in their investment.

Mutual Fund Based on Investment Objective

Growth Schemes

Growth schemes are ideal for capital appreciation in medium to longer term period as these schemes invest their money in equity funds. The funds carry high amount of risk in the short term but usually give lucrative returns in the long term.

Income Schemes

Income schemes are ideal for investors who are looking for steady income from their investment. The funds in the income scheme get invested in relatively safer government securities, bonds and corporate bonds.

Balanced Fund Schemes

Balanced fund schemes invest their funds equally in equity investments as well as debt investments. The ratio of risk involved in the investment is balanced in the balanced fund schemes. Balanced schemes are ideal for investors who don't have to take too much risk and at the same time want to avoid playing completely safe with their investments.

Money Market Schemes

The aim of money market schemes is to offer easy liquidity of the investment, capital preservation and income on the investment. Money market schemes invest normally in short term instruments like treasury bills, interbank money, commercial paper etc.

How Mutual Funds Work?

Mutual fund companies buy several bonds or stocks from the money pooled from small, large and other institutional investors, as per the advice of the professional investment advisor. A fund manager, which may either be a third-party organization or an individual, is responsible for managing the portfolio on behalf of the investors.

A skilled fund manager is hired by the board of directors of a mutual fund company to oversee and manage the bonds or stocks in the portfolio. The fund manager operates with the sole objective of achieving optimum growth and returns for the mutual fund investors. The fund manager is assisted by a group of investment professionals, each of whom are industry experts with specialized skills in different fields related to mutual fund investments like analyzing the right time for trading the assets in the portfolio, tracking fund performances, etc.

Some fund managers may own these funds, while some others are not. Fund managers collect the amount that investors would like to invest and then take their investment decisions, according to each of their unique financial objectives and risk appetites.

FAQs on What is Mutual Fund

How do you make money from a mutual fund?

There are different types of mutual funds, each of which generate returns of varying degrees depending on the market risks they are exposed to, sectors they are invested in, and various other factors. Short term mutual funds are exposed to high market risks and, hence, generate comparatively higher returns than most other types of mutual fund investments. Medium to long term investments, on the other hand, remain invested for a longer period of time to reduce market risks. Therefore, their returns are not as high as short term mutual fund investments. It is highly recommended that you regularly track the performances of funds in your portfolio, and sell and switch between funds to avert market risks and ensure capital growth.

What is an example of a mutual fund?

Balanced or hybrid mutual funds are long term investments that invest in a balanced combination of short term risky funds like equity mutual funds, and long term safe debt funds. The objective is to maintain a healthy balance of risky and less risky funds in the portfolio to balance out the risk and ensure capital growth.

What is mutual fund and how to invest in it?

A mutual fund is scheme is managed by an Asset Management Company. It collects finances that investors plan to invest in mutual funds and then invest them in equities, bonds and securities that are aligned with the financial objectives and risk appetites of each of the investors. You can invest in mutual funds online as well as offline. Leading mutual fund companies enable investors to invest in their schemes through their official website. There are also third party websites that offer investors the convenience of investing in mutual funds from across companies through a single unified online platform. If you prefer offline investments, you can visit the branches of mutual fund companies and invest in schemes of your choice.

Is there a chance of losing money in mutual fund investments?

There are different types of mutual funds, each of which generate returns of varying degrees depending on the market risks they are exposed to, sectors they are invested in, and various other factors. Short term mutual funds are exposed to high market risks and, hence, generate comparatively higher returns than most other types of mutual fund investments. Medium to long term investments, on the other hand, remain invested for a longer period of time to reduce market risks. Therefore, their returns are not as high as short term mutual fund investments. It is highly recommended that you regularly track the performances of funds in your portfolio, and sell and switch between funds to avert market risks and ensure capital growth.

Are mutual funds safe?

Whether a mutual fund is safe or not depends on the fund type. Different mutual funds are exposed to varying degrees of risk. For instance, equity mutual funds are short term investments and, therefore, have to be exposed to capital market risks to achieve growth within a short span of time. In contrast, balanced or hybrid mutual funds invest in a mix of equity funds and less risky debt funds to maintain balance in the portfolio and reduce risk exposure, while focusing on capital growth.

What are the four types of mutual funds?

The four leading types of mutual funds are equity funds, debt funds, balanced funds and money market funds.

Are mutual funds better than stocks?

Mutual funds and stocks, both, have their share of pros and cons. It is essential to understand their individual features and benefits and then invest according to your unique financial objectives and risk appetite.

Here are a few of their features at a glance

  • Mutual fund portfolios are managed by skilled fund managers who consistently monitor the performances of stocks, and weed out the ones that are not performing well or old stocks that are defunct now. The same cannot be said about stocks.

  • 15% short term capital gain is applicable on selling of stocks that had been purchased a year back. Stocks that are a part of mutual fund investments do not attract capital gains tax.

  • Fund houses bargain with intermediaries to lower the costs of stocks. The profits are indirectly passed on to the investors. Besides, you also don’t need a demat account. This does not hold true for stock investments.

  • Mutual funds offer instant diversification without having to invest in a robust corpus. A portfolio of stocks does not offer the same benefit.

What are the two advantages of mutual funds?

Here are the two advantages of mutual funds from many others:

  • Mutual fund portfolios are managed by skilled fund managers who consistently monitor the performances of stocks, and weed out the ones that are not performing well or old stocks that are defunct now. The same cannot be said about stocks.
  • 15% short term capital gain is applicable on selling of stocks that had been purchased a year back. Stocks that are a part of mutual fund investments do not attract capital gains tax.

What is the average rate of return on a mutual fund?

The reported average 10-year return on mutual fund investments ranges between 14% to 19%. However, the actual returns differ based on varied parameters like the type of mutual fund invested in, the number of years that the investor has stayed invested in the fund, etc.

Can you get rich by investing in mutual funds?

The right choices of mutual fund investments made at the right time can generate high returns for investor. Not just purchasing the right mutual funds, investors have to keep a close track of fund performances. This enables them to identify the funds that do not show a scope of generating healthy returns or funds whose growth is being restricted due to inflation. Investors can then sell a mutual fund that is not performing well or switch between funds to minimize risks and ensure growth of the portfolio.

What is a mutual fund and how does it work?

A mutual fund is a scheme that is managed by an Asset Management Company (AMC). The asset management company collects the investment amount from investors that they would like to invest and then invests it in equity mutual funds, securities, and bonds, as per their individual financial objectives and risk appetites.

Mutual fund companies buy several bonds or stocks, as per the advice of the professional investment advisor. A fund manager, which may either be a third-party organization or an individual, is responsible for managing the portfolio on behalf of the investors.

A skilled fund manager is hired by the board of directors of a mutual fund company to oversee and manage the bonds or stocks in the portfolio. The fund manager operates with the sole objective of achieving optimum growth and returns for the mutual fund investors. The fund manager is assisted by a group of investment professionals, each of whom are industry experts with specialized skills in different fields related to mutual fund investments like analyzing the right time for trading the assets in the portfolio, tracking fund performances, etc.

Some fund managers may own these funds, while some others are not. Fund managers collect the amount that investors would like to invest and then take their investment decisions, according to each of their unique financial objectives and risk appetites.

Why would you invest in a mutual fund?

Below are some of the benefits of investing in mutual funds:

  • Mutual fund portfolios are managed by skilled fund managers who are experts in constantly tracking the performances of stocks, and weed out the ones that are not performing well or old stocks that are defunct now. The same cannot be said about stocks.
  • Fund houses negotiate with intermediaries to lower the costs of stocks. The profits are indirectly passed on to the investors. Also, you don’t need a demat account. This does not hold true for stock investments.
  • Mutual funds offer instant diversification without having to invest in a huge corpus. A portfolio of stocks does not offer the same benefit.
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