Basics of Mutual Funds in India
Mutual Fund is a financial means that allows multiple investors to ‘pool’ their capital in order to put together an enormous savings corpus. This money is then invested by investment experts called Fund Managers who have deep knowledge about financial markets and investing in share market. The joint fund is invested in different asset segments like debt, equity, and liquid assets etc. The capital is referred to as ‘Mutual Fund’ because all gains or losses, risks, and returns associated with the investments done with the savings are jointly shared by the investors in accordance with their contributions.
A mutual fund is registered with SEBI (Securities Exchange Board of India). SEBI authorizes the AMC (Asset Management Company) overseeing the fund. There are several mutual funds in our country that are very similar to one another. To simplify matters, let us start with the basics of mutual funds. First, we should understand these two entities:
Company: A company is created when a group of individuals come together with the intention of doing business. Every company must have a distinct title and enlisted under The Companies Act, 1956.
Shares: It is your contribution or share within a company that can be in the form of minute ownership. For instance, if you own 50 shares of Rs. 100 each for XYZ Company, it means you have invested that much amount and now you own that much share in the company.
A person who studies the market and analyses the performance of company can directly buy or sell shares and invest in the stock market. But for people do not have good understanding of the market and cannot take good investment decisions themselves, Mutual Fund comes as an excellent option.
Just as you own shares in a company, Mutual Funds (MF) have ‘Units’ in the company. If you invest Rs 5,000 in XYZ MF and the cost for a unit is Rs. 10, you get 500 units of XYZ MF. As the MF grows over the time, the cost per unit also grows proportionately. Let us assume the initial corpus of a MF was Rs 100,000,000 and the cost per unit was Rs 10. After one year, the investment grew to Rs. 134,000,000, so the cost per unit will then be Rs 13.40 approx.
Following are some unique terms associated with mutual funds that every investor must know:
- Offer document –It is the formal document that summarizes the essential aspects of the fund. The document contains terms and conditions of the fund, the objective of the investment, the asset segment that the fund will be invested in and other details like performance history of the fund, who will handle the fund and the risks involved.
- NAV (Net Asset Value)– It is the price per share or cost per unit of the fund. The NAV varies depending on the performance of the fund. Units are traded at the current NAV or the value at the time of buying/selling.
- NFO (New Fund Offer): It is the new fund/scheme introduced by an AMC in the market. You can purchase units of the new funds at the offer price.
Types of Mutual Fund Schemes
The different types of mutual funds are classified on the basis of their structure, asset segment and investment objective.
Categories based on Structure:
- Open-Ended Funds:The units in this fund are open for redemption or purchase throughout the year. The redemption or purchase is done at current NAVs. These funds proffer liquidity to investors.
- Close-Ended Funds:The units in this fund can be bought only at the opening offer period. To support liquidity, these funds are listed on a stock market.
Categories based on Asset segment:
- Equity Funds: These funds invest in shares/ equity stocks of companies. Though these are high-risk funds, they tend to generate higher returns.
- Money Market Funds: These funds invest in liquid instruments such as CPs, T-Bills etc. They are reliable investments for people who want to invest excess funds for immediate but modest returns.
- Debt Funds: These funds invest in instruments like debentures, government bonds and fixed income resources. They are reliable investments and offer fixed returns.
- Sector Funds: These funds invest in a specific sector of the market. For instance Banking funds invest only in companies that associate with the banking sector. Returns are linked to the success of the sector and risk involved is dependent on the kind of the sector.
- Hybrid or Balanced Funds: These funds invest in a combination of asset segments. The percentage of equity may be higher than liability in some cases while it is just the opposite in others. In this way, risk and profits are balanced out.
- Tax-Saving Funds: These funds invest mainly in equity shares as investments in these funds are entitled for deductions specified under the Income Tax Act. The risk involved is quite high but you can get exceptional returns if performance of the fund is good.
- Index Funds: These funds invest in tools that mirror a specific index on the exchange in order to represent the performance and profits of the index like buying shares that represent NSE Sensex.
- Fund of funds: These funds invest in additional mutual funds. Profits depend upon the success of the objective fund.
Categories based on Investment objective:
- Income Funds:These funds invest money mainly in fixed-income tools like bonds and debentures with the intention of providing wealth protection and regular income to investors.
- Growth Funds:These funds invest money mainly in equity shares with the intention of providing wealth appreciation. They are risky funds that are ideal for investors who can afford long-term investments.
- Liquid Funds:These funds invest money mainly in temporary or interim tools like CPs and T-Bills with the intention of providing liquidity. They are low risk funds with modest returns.
Advantages of Mutual Funds
As mutual funds continue to gain popularity in India, numerous new funds and plans are launched in the market on a regular basis. Some of the advantages of investing in Mutual Funds are:
- Risks diversification:As the fund is invested in various securities, the risk gets diversified. The prospect of all the stocks performing poorly all at once is very less. Losses incurred on a few stocks are compensated by gains on others. This eventually minimizes risks.
- Organized investments:Mutual funds clearly specify the assets that are being targeted for investments so investors can direct their savings to various asset segments in a structured manner. The investors also gain access to schemes that were otherwise inaccessible to them like foreign securities.
- Professional supervision:Mutual funds are supervised by fund managers of AMCs. The managers utilize their financial investment knowledge to diminish risks and increase profits for investors.
- Reasonable investment alternative: MF is reasonable investment alternative for people who do not have considerable capital to endow in equity or tools that need a big investment. Moreover, the transaction cost is extended over multiple investors thereby reducing individual costs.
- Asset alternatives:Different kinds of asset alternatives are open for investors to choose from like debt, equity, hybrid sector, fund of funds, and index funds etc.
- Tax benefits:There are many funds/plans that have been created to work as tax-saving tools like equity linked saving schemes or ELSS. Investments in these plans are entitled for income tax deductions.
- Easy acquisition and redemption:Except for the lock-in period, funds can be purchased and sold easily at the current value or NAVs.
- Excellent returns:Mutual funds provide excellent returns on long-term investments as investors can branch out risk to increase overall returns.
- Safe investments:All MFs fall under SEBI which makes sure that the transactions are according to the regulations. This adds an element of security to the dealings.
- Flexibility:Several MFs offer flexibility by allowing investors to switch between plans/ funds to gain superior returns.
- SIP advantage:SIP (Systematic Investment Plan) lets investors put in small sums recurrently as an alternative to lump sum investment thereby attracting investors from different income levels.
Disadvantages of Mutual Funds
Though MFs come across as excellent investment options for all, there are some disadvantages associated with them as mentioned below:
- Costs and Risks: Unstable market conditions can generate variations in the cost of the investment. Additionally, there are expenses related to mutual fund investments that usually do not crop up when purchasing individual securities directly.
- Zero power: Investors cannot control the investment as fund managers take all the decisions. Investor can just contribute funds.
- No assurances: There are no assured returns because mutual funds invest in equities as well as debt. The profits depend upon market conditions.
How to invest in mutual funds
Mutual funds are easily accessible to investors. People can invest in them in the following ways.
- Direct:Investors can apply to a plan themselves by contacting the nearest AMC office or by logging on their website. Forms can be obtained or downloaded from the website and submitted at the office. The applications can be submitted online too. Online processing has become popular for reasons such as:
- Convenience: Funds can be applied right from one’s home or office.
- Comparison: There are numerous online financial service providers that can help view and compare funds and plans from different companies.
- Cost-effective: Investors can circumvent agents so the investments become cheaper as commissions are not included in the purchase cost.
- Choice: All the relevant information including brochures is available online for reference. This allows investors to make informed decisions.
- Professionals:These are agents who reach out to investors in order to provide information about different funds offered by a company. They help in the process of applying and dealing with issues like redemption, transfer of units, termination etc. The agents usually charge up to 6% as their commission. This fee is included in the buying value of fund units.
Mutual Funds offer several advantages but it is the responsibility of the investor to make reliable investments. You must choose funds bearing in mind your investment objective, liquidity needs, investment duration and affordability to make the most of Mutual Funds.