A Mutual Fund (MF) is formed when capital collected by various investors is invested in purchasing company shares, stocks, or bonds. Shared by thousands of investors, mutual funds investments are collectively managed by a professional fund manager to earn the highest possible returns.
Major Types of Mutual Funds:
Based on Asset Class
Mutual funds are broadly classified into three categories based on their investment traits and risks involved. Understand all mutual fund types and analyse them to check if your requirements would be served by investing in a particular type of mutual fund. Following are the types of mutual funds:
- Equity Funds: Equity funds primarily invest in shares of different companies. Your equity funds investment would make a profit when the share prices surge, while they suffer a loss when the share prices fall. Investing in equity funds is apt for those who stay invested for an extended period and are comfortable with moderate to high risk.
- Debt Funds: Debt funds primarily invest in fixed income government securities such as treasury bills and bonds, or reputed corporate deposits. Investing in debt funds is less risky than equity funds. Debt Funds are apt for those who are risk-averse and looking for a short-term investment.
- Balanced or Hybrid funds: As the name suggests, balanced or hybrid funds invest in both equity and debt instruments to balance the risk and maintain a specific rate of return. The fund manager decides the ratio to reap the best of both debt and equity instruments.
MF Types Based on Structure
- Open End Funds: The majority of mutual funds in India are open-end funds. These funds are not listed on the stock exchanges are available for subscription through the fund. Hence, the investors have the flexibility to buy and sell these funds at any time at the current asset value price indicated by the mutual fund.
- Closed-End Funds:- These funds are listed on the stock exchange. They have a fixed number of outstanding shares and operate for a fixed duration. The fund is open for subscription only during a specified period. These funds also terminate on a specified date. Hence, the investors can redeem their units only on a specified date.
7 Best Mutual Fund Apps to Invest Online
Benefits of Mutual funds:
There are a couple of benefits in investing in a mutual fund.
For example, if there is an investor who wants to invest in stocks but has no time to analyze and create a portfolio. Then he can be benefited from the mutual fund. This investor just has to buy a mutual fund and hence, in a single purchase he gets an investment similar to purchasing the entire portfolio of stocks.
The various benefits of investing in a mutual fund are described below:
- Diversification: A mutual fund has a number of securities like stocks, bonds, fixed etc already in its portfolio. Therefore, buying a mutual fund is a simple way to make a diversified investment. Further, diversification also reduces risk which is an added benefit of buying a mutual fund.
- Expert Money Management: Mutual fund companies have fund managers to choose the company shares, sectors, and debt papers in which the pooled mutual fund investment would be invested. This decision would be made by keeping the investors’ interest in mind.
- SIP Option: If you don’t have a lump sum to invest, then you can invest in a Systematic Investment Plan (SIP). The best thing about investing in mutual fund is that you can invest as low as Rs 500 an installment.
- Liquidity: Investing in Mutual Funds offer liquidity. You are allowed to redeem your investment at any time. There is no requirement of justifying your decision or searching for a buyer. You just have to place a request with your fund house and they will credit the money into your bank account within 3-7 working days.
- Tax Efficiency: Investing in ELSS offers a twin benefit of tax deductions and wealth accumulation. Investments in ELSS are eligible for tax deductions under Section 80C of the Income Tax Act, 1961. You can deduct a maximum of Rs 1,50,000 a year. ELSS offers the highest returns among all Section 80C instruments.
Disadvantages of Mutual Funds:
Here are the few disadvantages of buying a mutual fund:
- Fees and Expenses: There are a couple of possible fees in mutual funds like expense fee, exit fees etc which might reduce the overall returns. (You can choose direct mutual fund plans to reduce fees)
- No Insurance: There is no guarantee of success in the mutual funds. The mutual fund providing companies always state the following in the declaimer in their advertisements:
- Mediocre Performance: On an average, a majority of mutual funds are not able to beat the market indices.
- Loss of Control: The fund managers are responsible for buying and selling of the securities and you have no say in managing the portfolio. You are trusting someone else with your money when you invest in mutual funds.
How to make money by the mutual fund?
There are basically two ways to make money by a mutual fund –
- Appreciation: When the mutual fund appreciates i.e. when the fund grows in value. You can sell the mutual fund at the appreciated value and get a good return on your investment.
- Dividend Payment: Mutual funds also provide dividends to the investors when they receive the dividend from the companies they own in their portfolio. Please read the prospectus carefully if you are buying a mutual fund for dividend payments.
So, that’s all for the basics of the mutual fund. In the next post, I will describe how to buy a mutual fund.
In the meantime, if you need any help or have any doubts, feel free to comment below. I will be happy to help you.