Know The Basics of Mutual Funds

Imagine you wanted to start investing in the stock market. There are thousands of stocks to choose from, and being only one human you can only research about a few before you begin. Imagine you did your research and shortlist say 2 stocks - A & B. A seems to be a better bet so you go ahead and invest your money in A. Imagine things work out as per plan and you’re seeing a return of 10% or so in a year. Then, you happen to check on how stock B is doing, and you see a return of 18%! Suddenly, you realise you could’ve made almost double the returns.

What do you do now? How were you to know anyway? There probably wasn’t enough time to research all the stocks, and even if there was, there’s only so much you as a retail investor can know, especially when there are bigger sharks in the market. Is there really a fix for this? Or must you live with missing out on bigger returns?

Let's understand the basics of mutual funds.

What is Mutual Funds?

A mutual fund pools money from investors and invests it in a portfolio of permitted securities and other assets, such as equities, bonds and money-market instruments, according to the scheme’s investment objective. An actively managed mutual fund is managed by a professional fund management team. Scheme expenses, including management fees, are reflected in the fund’s expense ratio. Passive funds generally aim to track an index rather than select investments to outperform it and hence have a low expense ratio.

Mutual funds may suit investors who want diversified exposure to financial markets without selecting every underlying security themselves. They can also be suitable for investors who lack the time or expertise to research individual securities, although they still need to understand a scheme’s risks and objectives.

How To Invest In Mutual Funds?

Investors can generally choose between direct and regular plans of a mutual fund scheme. They may invest through an AMC or an eligible platform; regular plans are purchased through distributors. A direct plan is purchased without the involvement of a distributor whose commission is paid by the scheme. A regular plan is generally purchased through a mutual fund distributor.

In a direct plan, investors are responsible for making their own investment decisions unless they seek financial advice separately.

In India, an Asset Management Company (AMC) manages a mutual fund’s schemes under the applicable SEBI regulations and the fund’s governing documents. A broker won’t be there to help you with research in that case. A company that puts together a mutual fund is called an Asset Management Company (AMC). An AMC may offer multiple schemes with different investment objectives, asset allocations, risk profiles and costs.

Some investment platforms require a demat account, but it is not mandatory to invest in mutual funds. Units can also be held in the usual mutual fund account or statement-of-account form.

Types of Mutual Funds

The following are the types of mutual funds you can invest in.

Equity Funds

Equity mutual funds invest predominantly in equities, with the permitted allocation depending on the scheme’s category and mandate. Equity funds offer the potential for long-term capital appreciation, but their returns are volatile and are not guaranteed to exceed those of debt or money-market funds.

Equity funds generally carry market risk, with the level of risk varying by factors such as portfolio concentration, investment style and market capitalisation.

Equity funds include categories such as large-cap, mid-cap, small-cap, flexi-cap, focused, value, contra and sectoral or thematic funds, subject to applicable SEBI classifications.

Fixed-Income Funds

Debt mutual funds invest primarily in debt and money-market instruments, such as government securities, corporate bonds and Treasury bills. Debt funds earn returns from interest income and changes in the prices of their holdings. Their returns fluctuate, and investors may incur losses.

Debt funds have different risk profiles depending on their holdings and duration. They are not equivalent to guaranteed deposits and do not assure consistent returns.

Balanced or Hybrid Funds

Hybrid mutual funds combine asset classes, such as equities and debt, in proportions determined by their investment mandate or allocation strategy. The scheme allocates assets across permitted investments according to its category and stated investment strategy.

The risk of a hybrid fund depends on its asset allocation, holdings and strategy; it cannot be ranked uniformly between all debt and equity funds.

Money Market Funds

Money-market-oriented funds invest in short-term instruments such as Treasury bills, commercial paper, certificates of deposit and other permitted money-market securities. These funds have lower interest rate sensitivity than longer-duration debt funds, but they still carry credit, liquidity and other risks. Their returns are not guaranteed.

Index Funds

These funds aim to track the performance of a specific index such as Sensex or Nifty. The value of the mutual fund will fluctuate with the value of the index. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.

Sectoral Funds

Sectoral funds concentrate on a specific industry or sector, such as banking, healthcare or information technology. Thematic funds invest around a broader theme, while other specialised investment products may target real estate, commodities or environmental, social and governance considerations.

Fund-of-funds

These funds invest in other funds. A fund-of-funds can provide diversification through underlying funds, but its asset allocation depends on its investment strategy. Not every fund-of-funds is a balanced fund. A fund-of-funds may involve expenses at more than one level. Investors should review the total expense structure, including the costs of underlying funds, before investing.

Benefits of Investing In Mutual Funds

The following are the benefits of investing in mutual funds.

Convenience

Mutual funds can reduce the time needed to select and monitor individual securities. However, investors should still research the scheme’s objectives, holdings, costs and risks before investing.

Safe and Transparent

Mutual funds are subject to regulatory disclosure requirements, including information on performance, expenses and portfolio holdings. These disclosures help investors assess a scheme, but they do not eliminate investment risk or guarantee successful management.

Diversification

Mutual fund schemes are managed by professional investment teams, and the assets they oversee vary by fund and AMC.

Expert managers

Mutual fund managers are experts in their fields, usually managing thousands of crores of assets that they are responsible for. These funds aim to generate returns for investors at the lowest risk possible.

Liquid investment

Mutual funds offer high liquidity, with open-ended funds allowing investors to redeem their investments easily and smoothly.

FAQs

What is a mutual fund?

A mutual fund pools money from many investors and invests it in stocks, bonds, or other securities.

Who manages a mutual fund?

A professional fund manager manages the money according to the fund’s investment objective.

Are mutual funds safe?

Mutual funds are not risk-free. The level of risk depends on the type of mutual fund you choose.

Can I invest in mutual funds with a small amount?

Yes, you can start investing in many mutual funds with a small amount through options such as SIPs.