Over the past decade, mutual funds have become a favorite among investment experts and amateurs alike. They have attracted plenty of attention due to several good reasons like allowing one to build a diverse investment portfolio, offering an affordable way to save for retirement or help one achieve their financial goals for the short or long term. Just like you would with any other type of investment, it is important that you should ensure that you acquaint yourself with the basics surrounding mutual funds and get sufficient knowledge about how they function. This way, you will be able to make a far more informed decision with regards to your investment. Here, we take a look at some of the basics of mutual funds and other terms which you would frequently hear accompanying mutual funds.
What Is A Mutual Fund?
A mutual fund is like a pool of money collected from various investors who wish to invest the same in money market instruments like government bonds, company stocks, shares or commodities, etc. It can be compared to a collective fund raised with the help of several investors where the individual’s fund contribution is invested in stocks or shares of the investor’s choice, based on their financial goals. Essentially, mutual funds will allow you to invest in funds which you may have otherwise been unable to invest in, owing to the investment’s high costs. Additionally, mutual funds are managed by experienced and qualified fund managers who carry out thorough research in terms of the companies or funds to invest in, to ensure that the chosen fund will yield returns in sync with your financial goals. This is especially helpful for beginner investors who are not very well acquainted with the in’s and out’s of mutual funds and may not be in a position to make a financially sound decision.
Types of Mutual Funds
There are various types of mutual funds available which have been categorized on the basis of various factors. Three of the commonly available mutual funds are Debt mutual funds, Equity mutual funds and Balanced mutual funds.
- Debt Mutual Funds – These mutual funds will invest money in debt instruments like fixed income investments and Government Bonds in order to ensure, to an extent, that investors get fixed returns on their investment. These funds are relatively more stable than equity mutual funds and also carry lower risk.
- Equity Mutual Funds – These funds mainly invest in stock markets. Therefore, the returns are dependent on the performance of the market. These funds are ideal for long term investment as they usually provide better returns as compared to many other type of investments.
- Balanced Mutual Funds – As their name suggests, Balanced mutual funds are balanced in terms of risks and returns. Balanced mutual funds invest, in parts, in debt funds and equity funds in order to ensure returns on investment after a specified period of time.
- Open Ended Funds – These mutual funds do not have any restrictions in terms of entry and exit. Investors can invest in these funds at any time and also withdraw their investment at any time without having to go through any fund lock-in period. Exit or entry to these funds may carry a charge. Also, there are no restrictions in terms of the amount of shares which the fund can issue.
- Close Ended Funds – the characteristic features of close ended funds are that, unlike open-ended funds, they have a lock-in period, usually of 3 years, before which the investors cannot withdraw their funds. Also, unlike open-ended shares where new shares are issued to meet the investor demand, only a limited number of shares are issued and no new shares will be issued to meet investor demand.
- ELSS or Equity Linked Savings Schemes – As the name suggests, ELSS is also known as the tax saving fund since investments done in ELSS fund are exempt from tax under Section 80C. these funds however do have a lock-in period of at least 3 years.
- Sectorial Funds – Taking a cue from their name, Sectorial funds invest mainly in a particular sector like infrastructure, real-estate, banking, etc. Money invested in these funds is further re-invested by the fund manager in stocks belonging to a specific sector which the fund has been created for. For example, an infrastructure fund will only invest in stocks of infrastructure companies.
Regulation of Mutual Funds in India
In India, all the money that has been invested in mutual funds which have been raised by any company is regulated by SEBI (Securities & Exchange Board of India). SEBI not only regulates these companies but also creates norms and policies pertaining to the functioning of these mutual funds, in order to ensure the safety of the investor’s money from acts of fraud or embezzlement. However, the returns on mutual fund investments are dependent on the market performance, as a result of which they cannot be guaranteed by SEBI. Returns may be high or low depending on the market performance.
Asset Management Company (AMC)
An Asset Management Company or AMC is the company which handles the funds invested by the investors. The company which floats the mutual fund will appoint an Asset Management Company to manage the assets or capital raised via mutual funds.
Role of Fund Managers
Fund Managers are essentially experienced professionals who handle and manage the capital which has been invested in a mutual fund. The job of a fund manager is to ensure that each investor’s capital is invested in a fund which will yield maximum returns for the investor. Their job is also to minimize the losses in case of a market crash. Ideally, fund managers must hold in-depth experience and a keen understanding of the market in order to best decide where the funds should be invested, when they must be invested , how much to invest and when to exit the fund.
A portfolio is a collective term which refers to the spectrum of investments held by an individual investor. An investor’s portfolio could include a variety of investments like PPF, FDs, Gold, Debt, Equity, etc. However, in terms of mutual funds, a portfolio describes the collective investments which have been made under a specific fund and also in form of cash.
Entry / Exit Load
Particular mutual funds carry special charges which are levied at the time of entering the fund or at the time of withdrawing or exiting the fund. The charge levied at the time of investing in the fund is known as Entry Load. Exit Load is the charge levied when the investor wishes to withdraw their capital from the fund. Normally, entry or exit load is very nominal and charged at the rate of 2% on the invested amount.
Net Asset Value (NAV)
When investing in mutual funds, you are assigned a specific number of units on the basis of the amount which you have invested. NAV or Net Asset Value is the price of each unit or share. You can easily track a fund’s performance with the help of NAV.
How To Track Mutual Fund Performance
The performance of a mutual fund can be easily tracked with the help of NAV or net asset value of share units. Change in the price of each share is indicative of the performance of the market. If the per unit price has gone up, It means that the market performance is good and vice versa.
For example, you invest a sum of Rs 1000 in XYZ fund. The prevailing NAV is Rs 10 per unit, on the basis of which you will be allotted 100 units of XYZ fund. If the NAV goes up to Rs 15 per unit, your original investment (100 units) will be worth Rs 1500 and you will get returns worth Rs 500.
Mutual Fund investments will be subject to market risks. Any mutual fund listed in the document does not guarantee fund performance or its underlying creditworthiness. Do read the mutual fund document thoroughly before investing. Specific investment needs and other factors have to be taken into account while designing a mutual fund portfolio.
GST rate of 18% applicable for all financial services effective July 1, 2017.