“Mutual fund sahi hai”- we’ve all heard this catchphrase, right? But do you understand what mutual funds are? If not, don’t worry – we’re here to help. We’ll provide you with a clear explanation of mutual funds, the different types available for investment, and the benefits of investing in them.
What is a Mutual Fund?
A mutual fund is an investment tool that pools funds from multiple investors and uses it to invest in equities, bonds, government securities, gold, etc. Mutual funds are managed by fund managers who specialise in analysing and handling investments. These professionals invest the pooled funds in various financial assets based on the mutual fund’s scheme’s inherent investment objective. In simple terms, fund managers are responsible for making investment decisions on behalf of the investors.
Types of Mutual Funds
Mutual funds are generally categorised into three groups – based on structure, investment goals, and asset classes. There are various other types of mutual funds as well that we shall discuss in more detail below.
Based on Structure
Based on structure, mutual funds are further divided into open-ended, close-ended and interval funds. Here’s an overview of what each type has to offer.
Open-ended Funds: Open-ended mutual funds allow you to invest and withdraw your investment anytime. Meaning, they don’t have a fixed maturity period and are liquid and perpetual in nature. Fund managers generally invest in assets that offer a greater potential for returns.
Close-ended Funds: Close-ended mutual funds have a fixed maturity period. You can invest in these funds only as part of a New Fund Offer (NFO). Consequently, you can withdraw your investment only upon completion of the maturity period. Although these funds can be listed on stock exchanges, their liquidity is generally very low.
Interval Funds: These funds are similar to close-ended funds but combine the features of open-ended funds. You are allowed to purchase or withdraw your investments during a specified transaction period or interval.
Based on Investment Goal
Based on the goal or objective of the investment, mutual funds are further categorised into growth, income and capital protection funds. An outline of each type is given below.
Growth Funds: Growth funds are designed to increase your capital or investment over a longer period, as the name implies. A wealth manager may recommend investing in growth-oriented assets, such as equity funds, which have the potential for higher returns but also come with higher risk. This type of mutual fund may better suit individuals who can handle market volatility.
Income Funds: Income funds aim at providing stable returns to investors. Wealth managers recommend that investors put their money into securities with a fixed income and a predetermined maturity date. The fund manifests gains through interest income and any capital gains resulting from changes in the value of the deposits.
Capital Protection Funds: Capital protection funds are mutual fund schemes that prioritise safeguarding the initial investment amount while providing investors with a chance to earn some returns. They use various investment strategies and financial instruments to achieve this goal and aim to limit the risk of loss, particularly in volatile market conditions. As a result, they are considered less risky than other investment options.
Based on Asset Classes
Based on asset classes, mutual funds are further classified into equity, debt and hybrid funds, all of which have been discussed below.
Equity Funds: Equity funds primarily invest in stocks or equity-related instruments to generate capital appreciation. The performance of the units purchased determines the gains and losses. That said, equity funds carry a higher risk due to stock market volatility.
Debt Funds: Debt mutual funds usually invest in fixed-income securities like government and corporate bonds, treasury bills, and other money market instruments. They aim to generate regular income for investors while preserving the principal amount. It is a great option for people looking for low-risk investment options.
Hybrid Funds: As the name suggests, hybrid funds invest in both equity and debt funds, offering a balanced approach to generating capital appreciation and risk mitigation. This investment option is ideal for those willing to take on calculated risk.
Some Other Important Types of Mutual Funds
Some other noteworthy mutual fund types are sectoral, thematic and index funds. Sectoral funds focus on specific sectors of the economy, like healthcare, technology, etc., allowing investors to target industries they believe will perform well. On the other hand, thematic funds invest in particular themes, like artificial energy, sustainable energy, etc. Lastly, index funds aim to replicate the performance of a specific market index, providing investors with broad exposure to the overall market.
Benefits of Investing in Mutual Funds
Now that we’re familiar with mutual funds and their types, let us look at some benefits that have made mutual funds increasingly popular among investors.
Professional Management
Mutual funds are managed by fund managers who use their expertise and experience to earn gains on behalf of investors, in turn fulfilling the scheme’s investment mandate. They continuously monitor and rebalance the portfolio according to current market conditions.
Diversification
Mutual funds pool money from multiple investors and use it to invest in various assets, including stocks, bonds, and more. This diversification helps spread risk across different investments, reducing the potential negative impact of any one investment on the overall portfolio.
Cost-Effective
Mutual funds are a cost-effective option for investing in a diversified portfolio of stocks and debt securities. Investing in individual securities can be challenging due to associated costs, but mutual funds have a low expense ratio and a more affordable minimum initial investment cost, making them a better option for easy access to the stock market.
Goal Planning
When it comes to investing, mutual funds offer various options that can match your specific goals and risk tolerance, allowing wealth managers to customise your portfolio to meet your needs and expectations.
Liquidity
Mutual funds can be easily redeemed or liquidated on any business day. This allows investors to convert their investments into cash when necessary. This, however, applies explicitly to open-ended mutual funds, as close-ended funds can only be withdrawn after maturity.
Transparency
Mutual funds are usually transparent about their holdings. By providing clear and concise information to investors, these funds help build trust and confidence in the investment process.
Well Regulated
The mutual fund industry in India is regulated by the capital market regulator Securities and Exchange Board of India (SEBI). Therefore, mutual funds must adhere to the strict rules and regulations laid out to safeguard investors, manage risk, ensure liquidity, and maintain fair valuation.
Conclusion
In recent years, the mutual fund industry in India has experienced significant growth. More individuals are realising the benefits of investing in mutual funds to achieve their short-term and long-term financial objectives. Investors can rely on mutual funds as an option that has the potential to provide significant returns in the future. They, however, need to understand the fundamentals of mutual funds and their benefits to make informed decisions. An experienced wealth manager can considerably simplify your investment process. With the proper knowledge and guidance, mutual funds can be a smart choice for investors looking to secure their future financially.
Please let us know your thoughts on this post by leaving a reply in the comments section. Also, check out our recent post on “How are Corporate FDs Different from Bank FDs?“
Disclaimer – This article is for educational purposes only, and by no means, intends to substitute expert advice. Mutual fund investments are subject to market risks. Please read the offer document carefully before investing.
